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Table of Contents

As filed with the Securities and Exchange Commission on December 18, 2012

Registration No. 333-184715

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form S-1/A

(Amendment No. 2)

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

Home Loan Servicing Solutions, Ltd.

(Exact Name of Registrant As Specified in Its Charter)

 

Cayman Islands   6162   98-0683664

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

Home Loan Servicing Solutions, Ltd.

c/o Intertrust Corporate Services (Cayman) Limited (formerly Walkers Corporate Services Limited)

190 Elgin Avenue

George Town, Grand Cayman KY1-9005

Cayman Islands

Telephone: +(345) 943-3100

(Address, Including Zip Code, and Telephone Number,

Including Area Code, of Registrant’s Principal Executive Offices)

C T Corporation System

111 Eighth Avenue

New York, New York 10011

(212) 894-8940

(Name, address, including zip code, and telephone number,

including area code, of agent for service)

Copies to:

William C. Erbey

Home Loan Servicing Solutions, Ltd.

2002 Summit Boulevard, Sixth Floor

Atlanta, Georgia 30319

Telephone: (561) 682-7721

 

Christopher S. Auguste, Esq.

Kramer Levin Naftalis & Frankel LLP

1177 Avenue of the Americas

New York, New York 10036

Telephone: (212) 715-9100

 

Danielle Carbone, Esq.

Shearman & Sterling LLP

599 Lexington Avenue

New York, New York 10022

Telephone: (212) 848-4000

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer  ¨

  Accelerated Filer  ¨    Non-Accelerated Filer  x   Smaller reporting company  ¨

(Do not check if a smaller reporting company)                                        

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

    

Proposed

Maximum

Aggregate

  Offering Price(1)  

     Amount of
Registration Fee(2)(3)

Ordinary shares, par value $0.01 per share

     $480,000,000      $65,472.00

 

 

 

(1) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended. Includes the offering price of additional shares that the underwriters have the option to purchase.
(2) Calculated pursuant to Rule 457(o) under the Securities Act of 1933, as amended.
(3) Includes $47,740.00 previously paid.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion, dated December 18, 2012

PROSPECTUS

22,000,000 Ordinary Shares

 

LOGO

 

 

 

We are offering ordinary shares. The public offering price of our ordinary shares is $         per share.

Our ordinary shares are listed for trading on The NASDAQ Global Select Market under the symbol “HLSS.” The last reported sale price of our ordinary shares on December 17, 2012 was $18.37 per share.

 

 

Investing in our ordinary shares involves risks that are described under “Risk Factors” beginning on page 21.

 

       Per Share      Total

Price to public

     $              $        

Underwriting discounts and commissions

     $              $        

Proceeds, before expenses, to us

     $              $        

We have granted the underwriters an option for a period of 30 days from the date of this prospectus to purchase up to an additional 3,300,000 ordinary shares from us, at the public offering price, less the underwriting discounts and commissions. If the underwriters exercise the option in full, the total underwriting discounts and commissions payable by us will be $                     and the total proceeds to us, before expenses, will be $                    .

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the ordinary shares to purchasers on or about                     , 2012.

 

 

 

Wells Fargo Securities   Barclays   BofA Merrill Lynch   Citigroup

 

Keefe, Bruyette & Woods   Sterne Agee

Prospectus dated                     , 2012.


Table of Contents

TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1   

RISK FACTORS

     21   

FORWARD-LOOKING STATEMENTS

     48   

INDUSTRY DATA

     50   

USE OF PROCEEDS

     51   

DIVIDEND POLICY

     52   

CAPITALIZATION

     54   

THE MORTGAGE SERVICING INDUSTRY

     55   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     60   

THE BUSINESS

     98   

MANAGEMENT

     125   

COMPENSATION DISCUSSION AND ANALYSIS

     132   

PRINCIPAL SHAREHOLDERS

     137   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     138   

DESCRIPTION OF SHARE CAPITAL

     142   

MARKET FOR OUR ORDINARY SHARES

     142   

SHARES ELIGIBLE FOR FUTURE SALE

     149   

MATERIAL CAYMAN ISLANDS AND UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS

     150   

ENFORCEABILITY OF CIVIL LIABILITIES

     155   

UNDERWRITING

     156   

LEGAL MATTERS

     165   

EXPERTS

     165   

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     165   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

 

 

We are responsible for the information contained in this prospectus and in any related free writing prospectus we prepare or authorize. Neither we nor the underwriters and their affiliates have authorized anyone to give you any other information. We do not, and the underwriters and their affiliates do not, take any responsibility for, and can provide no assurance as to the reliability of, any information that others may give you. We are offering to sell, and seeking offers to buy, our ordinary shares only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date on the front cover of this prospectus, or other earlier date stated in this prospectus, regardless of the time of delivery of this prospectus or of any sale of our ordinary shares.

For investors outside of the United States: neither we nor any of the underwriters has done anything that would permit this offering outside the United States or to permit the possession or distribution of this prospectus outside the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of our ordinary shares and the distribution of this prospectus outside of the United States.


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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information that you should consider in making your investment decision. Before investing in our ordinary shares, you should carefully read this entire prospectus, including our consolidated financial statements and the related notes included elsewhere in this prospectus. You should also consider, among other things, the matters described under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “The Business” appearing elsewhere in this prospectus. Unless otherwise stated, all references to “us,” “our,” “we,” the “Company” and similar designations refer to Home Loan Servicing Solutions, Ltd. and its consolidated subsidiaries.

Our Company

We are a Cayman Islands exempted company that acquires mortgage servicing assets consisting of mortgage servicing rights, rights to mortgage servicing rights, associated servicing advances and other related assets. We launched our operations on March 5, 2012 using the proceeds from our initial public offering and a concurrent private placement with our founder and Chairman of our Board of Directors to acquire mortgage servicing assets relating to a portfolio of subprime and Alt-A mortgage loans with an unpaid principal balance of $15.2 billion from Ocwen Loan Servicing, LLC, or “Ocwen Loan Servicing.” As of March 31, 2012, our total assets and total liabilities were $546 million and $368 million, respectively. As of September 30, 2012, our total assets and total liabilities increased to $1,703 million and $1,285 million, respectively. Since completing our initial acquisition of mortgage servicing assets, we have purchased additional mortgage servicing assets from Ocwen Loan Servicing, and as of September 30, 2012, we had acquired mortgage servicing assets with an unpaid principal balance of approximately $48.0 billion from Ocwen Loan Servicing.

We do not originate or purchase mortgage loans, and as a result we are not subject to the risk of loss related to the origination or ownership of mortgage loans. We have engaged Ocwen Loan Servicing, a high quality residential mortgage loan servicer, to service the mortgage loans underlying our mortgage servicing assets and therefore have not and do not intend to develop our own mortgage servicing platform. While we have only completed two full quarters of operations, we believe that our revenue and expense structure is predictable and will generate a stable income stream and that the quality of our assets is and will continue to be strong. We believe this combination will accomplish our primary objective of delivering attractive and consistent risk-adjusted returns to our shareholders. We intend to distribute at least 90% of our net income over time to our shareholders in the form of a monthly cash dividend. In addition, unlike many income-oriented investment alternatives, we believe that our income stream and the valuation of our assets are not substantially correlated to movements in interest rates.

Our results of operations for the quarter ended September 30, 2012 reflect consistent earnings that were in line with our expectations.

We reported net income of $6.6 million, or $0.37 per ordinary share, for the third quarter of 2012. Our third quarter business performance highlights include the following:

 

   

declaration of dividends of $0.10 per share per month totaling $5.9 million for the quarter.

 

   

receipt of net proceeds of $236.0 million in connection with our public offering of 16,387,500 shares at $15.25 per ordinary share that closed on September 12, 2012. The net proceeds from the offering were used to acquire mortgage servicing assets from Ocwen Loan Servicing with an unpaid principal balance of $27.8 billion.

 

   

completion of the acquisition of mortgage servicing assets with an unpaid principal balance of $2.1 billion from Ocwen Loan Servicing on August 1, 2012.

 

 

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On September 13, 2012, we amended and restated the servicing advance facility agreements that we originally entered into simultaneously with the closing of our initial public offering and the Initial Ocwen Purchase to (i) add Wells Fargo Securities, LLC as an administrative agent, (ii) create a master trust (the “Trust”) that can issue multiple series of notes with varying maturity dates and credit ratings ranging from AAA to BBB, including 2a-7 money market eligible notes and medium term notes and (iii) allow for deferred servicing fees to be included in the borrowing base as principal and interest advances for pooling and servicing agreements that meet certain conditions. This resulted in a reduced cost of our financing. The servicing advance facility agreements, as amended and restated, are referred to throughout this prospectus as the “Servicing Advance Facility Agreements.”

Our executive management team has extensive experience in the mortgage servicing industry and each of our executive managers was formerly in a senior management role at Ocwen. We believe our executive management team’s extensive experience provides us with the ability to assess the vital characteristics of the mortgage loans underlying the mortgage servicing assets we have acquired and may seek to acquire and evaluate the quality of our current and potential mortgage servicers. We believe this experience further enables us to accurately value mortgage servicing assets and better forecast future asset performance and servicing cash flows. In addition, our management team has demonstrated historical success in arranging cost-effective servicing advance financing through a variety of economic cycles. Under the terms of our professional services agreement with Ocwen, which we refer to as the “Ocwen Professional Services Agreement” throughout this prospectus, the Company and its management team provide Ocwen valuation and analysis services for mortgage servicing rights, advance financing management, treasury management, legal services and other similar services. See “The Business—Description of Ocwen Professional Services Agreement” for a detailed description of the Ocwen Professional Services Agreement. None of our officers or employees holds positions at Ocwen or its affiliates. Nonetheless, because of our management team’s past or current relationships with Ocwen, conflicts of interest could occur with respect to the services performed under the Ocwen Professional Services Agreement or the other agreements the Company has with Ocwen. Matters that could give rise to conflicts include pricing, valuation and quality of assets or services that Ocwen and the Company purchase from one another, including Mortgage Servicing Assets (as defined below) or services under the Ocwen Professional Services Agreement. In addition, William C. Erbey, the Chairman of our Board of Directors, is the Chairman of the Board of Directors of Ocwen. See “Risk Factors—We could have conflicts of interest with Ocwen, and our officers and directors could have conflicts of interest due to their relationships with us and Ocwen, that could be resolved in a manner adverse to us” and “—We are highly dependent upon our senior management team” for a description of the risks associated with the Company providing services to Ocwen, and Ocwen providing services to the Company, under the Ocwen Professional Services Agreement and other agreements. We will seek to mitigate these potential conflicts through oversight by the independent members of our Board of Directors.

Our business strategy is focused on acquiring mortgage servicing rights. In many cases, however, the transfer of legal ownership of mortgage servicing rights requires the prior approval or consent of various third parties, including rating agencies. If the seller from whom we have agreed to purchase mortgage servicing rights has not obtained the necessary approvals and consents to transfer legal ownership of the mortgage servicing rights to us, we will instead seek to acquire the rights to receive the servicing fees that the current servicer is entitled to receive, and the current servicer will continue to service the mortgage loans and receive compensation from us for its servicing activities. We refer to these rights, along with the right to acquire legal ownership of the related mortgage servicing rights automatically upon obtaining the necessary approvals and consents to transfer the mortgage servicing rights, as “Rights to MSRs.” Acquiring Rights to MSRs results in the Company recording assets such as Notes Receivable—Rights to MSRs and match funded advances, and liabilities such as match funded liabilities. It also entitles us to collect the contractual servicing fees related to such Rights to MSRs, which are typically 50 basis points annually of the unpaid principal balance of the related mortgage loans. Servicing fees collected are reduced by the

 

 

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portion of fees paid to Ocwen, and the retained fees are further reduced by the amortization of the Notes Receivable—Rights to MSRs, to arrive at revenue or Interest Income—Notes Receivable—Rights to MSRs. This source of revenue allows us to pay operating expenses and other expenses such as interest expense on the match funded liability, and the income that remains is expected to compensate our investors for their investment. These balances are expected to grow in the future in periods where we are acquiring additional Mortgage Servicing Assets. In periods when we are not acquiring additional Mortgage Servicing Assets, these balances would likely decrease as the underlying mortgage loans are repaid. See “Management’s Discussion and Analysis—Primary Components of Income” and “The Business—Our Economic Model” for a complete description of our components of income and expenses.

Upon receipt of the necessary third party approvals and consents, the seller is obligated to transfer legal ownership of the mortgage servicing rights to us without any additional payment. Whether we acquire mortgage servicing rights or Rights to MSRs, we also acquire servicing advances and other associated assets. We do not believe that our business strategy or economic performance has been or will be materially affected by whether we directly own mortgage servicing rights or the related Rights to MSRs. All of our acquisitions of mortgage servicing assets to date have been structured as acquisitions of Rights to MSRs and we expect that any additional acquisitions of mortgage servicing assets will be structured in the same manner, at least in the near term.

Throughout this prospectus, when we refer to our “Mortgage Servicing Assets,” we are referring to the Rights to MSRs that we own and the mortgage servicing rights that we may acquire in the future, and when we refer to “Purchased Assets,” we are referring to the Mortgage Servicing Assets, together with the associated servicing advances and any other assets related to such Mortgage Servicing Assets that we have acquired. We refer to the mortgage servicing rights related to the Rights to MSRs that we have acquired and any mortgage servicing rights we may acquire in the future and which are or will be serviced by Ocwen Loan Servicing as the “Ocwen Mortgage Servicing Rights.”

We have not and do not intend to develop our own mortgage servicing platform but instead will rely on high quality third-party residential mortgage loan servicers. All of the Rights to MSRs that we have acquired to date have been acquired from, and are serviced by, Ocwen Loan Servicing. Ocwen Loan Servicing is a leader in the residential subprime and Alt-A mortgage servicing industry based on its historical servicing performance through a variety of real estate and economic cycles. Prior to the transfer of legal ownership of any Ocwen Mortgage Servicing Rights to us, Ocwen Loan Servicing will remain obligated to service the underlying mortgage loans and will remit to us the servicing and other related fees (excluding any ancillary income that Ocwen Loan Servicing will retain) it collects in each month related to the Rights to MSRs. Following the transfer of legal ownership of any Ocwen Mortgage Servicing Rights to us, Ocwen Loan Servicing will service the underlying mortgage loans on our behalf as subservicer, and we will receive the servicing and other related fees (excluding any ancillary income). As compensation for its servicing and subservicing activities, Ocwen Loan Servicing receives from us a monthly base fee initially equal to 12% of such recognized servicing fees collected each month. Ocwen Loan Servicing also earns a monthly performance-based incentive fee that fluctuates based on collections and servicing advance reduction criteria with respect to the underlying mortgage loans. We believe this arrangement aligns the interests of both companies. We will compensate Ocwen Loan Servicing for the services it performs for us prior to the transfer of legal ownership of the Ocwen Mortgage Servicing Rights to us. The method used to calculate the fees that we pay to Ocwen Loan Servicing under the Purchase Agreement with respect to the Rights to MSRs is the same as the method used to calculate the fees that we will pay to Ocwen Loan Servicing under the Subservicing Agreement with respect to any Ocwen Mortgage Servicing Rights that we subsequently acquire. As a result, the compensation to be paid to Ocwen Loan Servicing will not vary based on whether Ocwen Loan Servicing or we hold legal title to the underlying Ocwen Mortgage Servicing Rights.

The assets we have purchased from Ocwen to date have pertained solely to subprime and Alt-A loans. This reflects the fact that the majority of the assets Ocwen owns pertain to servicing subprime and Alt-A

 

 

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loans. Additionally, the prepayment rate on subprime and Alt-A loans has demonstrated little correlation to interest rates in recent years which is a characteristic that we find attractive and which fits within our business strategy.

We intend to continue to acquire assets pertaining to subprime and Alt-A mortgage loans that were originated prior to 2008. Given the low volume of originations of subprime and Alt-A loans since 2007, at some point in the future we may be unable to acquire sufficient similar assets, which would likely cause us to reduce or not be able to pay dividends to our shareholders and we would reevaluate our long-term business strategy at such time. If we are unable to acquire sufficient assets meeting our investing criteria, we may return cash to shareholders in the form of increased dividends, a special dividend or share repurchases, the effect of which may be to reduce future earnings and dividends. See “Risk Factors—A significant increase in prepayment speeds would reduce the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets and could adversely affect our operating results” and “—We may be unable to maintain the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets at an adequate level, which may cause administrative expenses to increase relative to our equity base” for a description of risks associated with the acquisition of subprime and Alt-A mortgage loans.

We anticipate future growth through subsequent acquisitions of Mortgage Servicing Assets. As part of our strategy to acquire additional Mortgage Servicing Assets, we expect to acquire over time substantially all of Ocwen Loan Servicing’s remaining mortgage servicing rights relating to subprime and Alt-A mortgage loans, which had an unpaid principal balance of approximately $63.8 billion as of September 30, 2012. In addition, in connection with Ocwen’s announced acquisition of Homeward Residential Holdings, Inc. and Ocwen Loan Servicing’s announced acquisition of certain assets of Residential Capital, LLC, Ocwen and Ocwen Loan Servicing are anticipated to acquire additional rights to service mortgage loans with approximately $120.0 billion of unpaid principal balance that are similar to those in our current portfolio. We believe that Ocwen perceives that it has benefited from the transfer of Rights to MSRs to us in connection with our previous acquisition transactions. Although we cannot guarantee that future acquisition transactions will occur, we also believe that Ocwen will benefit from such transactions and therefore will continue to sell mortgage servicing assets to us in this manner which will allow us to maintain or grow the unpaid principal balance of our servicing portfolio.

We intend to continue to acquire additional similar mortgage servicing assets from Ocwen in the near term in two ways:

 

   

In order to remain fully invested and to offset the impact of prepayments in our servicing portfolio, we expect to continue to utilize cash flow from operations in excess of our dividend to purchase mortgage servicing assets that are similar to our initial portfolio from Ocwen Loan Servicing under substantially similar terms. We refer to such transactions as “flow transactions.” We expect flow transactions to take place at regular intervals. Certain terms of such flow transactions, including the servicing incentive fee and advance ratio targets, will vary over time through these transactions.

 

   

In order to increase the scale of our business we will look for opportunities to issue additional equity in the form of ordinary shares to allow us to execute larger purchases of mortgage servicing assets similar to our initial portfolio from Ocwen under similar terms. We refer to such transactions as “follow on purchases.” These follow on purchases will be subject to equity market conditions and will likely require that additional advance financing capacity be arranged in advance or concurrent with each transaction in order to maintain leverage similar to our current level.

Although we believe that competitive and regulatory dynamics in the mortgage servicing industry will present us with opportunities to acquire Mortgage Servicing Assets from banks, other financial institutions and independent mortgage servicers and we remain open to purchasing mortgage servicing assets from

 

 

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third parties other than Ocwen Loan Servicing, given the large amount of mortgage servicing assets remaining at Ocwen Loan Servicing, we do not view initiating purchases from other third parties as a near-term priority. The provisions of our Amended and Restated Memorandum and Articles of Association (“Articles of Association”) restrict our ability to issue and sell additional ordinary shares at a price below our then current net asset value per share without first obtaining the prior approval of holders of at least a majority of the outstanding ordinary shares voted with respect to such approval. Future sales of ordinary shares by us will dilute the ownership percentage of our then-existing shareholders, including shareholders that purchase in this offering.

We were incorporated as an exempted company in the Cayman Islands, which currently does not levy income taxes on individuals or companies. We expect to be treated as a passive foreign investment company (“PFIC”) under U.S. federal income tax laws. We intend to distribute at least 90% of our net income over time to our shareholders in the form of a monthly dividend that will primarily be based on projected annual earnings, although we are not required by law to do so. Payment of a monthly dividend is not a condition of our tax status, and our decision to pay this dividend is not expected to be impacted by any changes in our status for U.S. tax purposes. Except for our subsidiary that is taxed as a corporation for U.S. federal income tax purposes, we do not expect to be treated as engaged in a trade or business in the United States and thus do not expect to be subject to more than a nominal amount of U.S. federal income taxation.

Since the closing of our initial public offering, we paid monthly dividends of $0.10 per ordinary share through September 2012 (except during the month of March in which we paid a pro-rated amount of $0.08 per ordinary share), a dividend of $0.11 for October 2012 and a dividend of $0.12 for November 2012. On November 15, 2012, our Board of Directors increased the previously declared dividend for the months of November and December 2012 by $0.01 to $0.12 per ordinary share.

The following table sets forth the record and payment dates of the dividend that has been declared by our Board of Directors, but is unpaid, for the month of December 2012:

 

Record Date

   Payment Date    Amount per
    Ordinary Share    
 
December 31, 2012    January 10, 2013    $ 0.12   

Our Board of Directors has the right to rescind declared, but unpaid dividends at any time prior to the applicable dividend payment date. See “Dividend Policy” and “Description of Share Capital.”

If we do not qualify as a PFIC, or if a shareholder does not make a QEF election if we do qualify as a PFIC, dividends paid out of our current or accumulated earnings and profits (other than excess distributions which are discussed in “Material Cayman Islands and United States Income Tax Considerations”) will be taxable as dividends for U.S. federal income tax purposes. Although our earnings and profits are calculated as of the end of the taxable year, we expect that all of our future dividends will be paid out of our current earnings. If we qualify as a PFIC, and a shareholder makes a QEF election, the shareholder will be taxable for U.S. federal income tax purposes on the shareholder’s pro rata portion of our earnings each year. In that case, the shareholder would not be taxed again when any previously taxed earnings are distributed to the shareholder. The tax basis in a shareholder’s shares will increase by any earnings the shareholder is taxed on, and decreased by any distributions of previously taxed earnings. See “Material Cayman Islands and United States Federal Income Tax Considerations.”

 

 

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Acquisitions of Mortgage Servicing Assets

The Initial Ocwen Purchase

On March 5, 2012, we consummated our initial acquisition of Mortgage Servicing Assets from Ocwen Loan Servicing (the “Initial Ocwen Purchase”). The Mortgage Servicing Assets that we purchased in connection with the Initial Ocwen Purchase were a portion of the assets acquired by Ocwen Loan Servicing when it acquired the U.S. subprime mortgage servicing business known as “HomEq Servicing” on September 1, 2010. The business acquired by Ocwen Loan Servicing included the mortgage servicing rights and associated servicing advances of HomEq Servicing, as well as the servicing platform based in Sacramento, California and Raleigh, North Carolina. The sellers were Barclays Bank PLC and Barclays Capital Real Estate Inc. (collectively, “Barclays”). The unpaid principal balance of the subprime and Alt-A mortgage loans underlying the mortgage servicing rights acquired in the Initial Ocwen Purchase was approximately $15.2 billion and the amount of associated servicing advances outstanding was approximately $413.4 million, in each case as of March 5, 2012. We funded the Initial Ocwen Purchase with a portion of the net proceeds from our initial public offering.

Pursuant to a master servicing rights purchase agreement between Ocwen Loan Servicing and HLSS Holdings, LLC, or “HLSS Holdings,” which we refer to as the “Purchase Agreement” throughout this prospectus, we purchased the following:

 

   

the contractual right to receive the servicing fees (excluding any ancillary income) related to the initial Ocwen Mortgage Servicing Rights;

 

   

the contractual right to receive any investment earnings on the custodial accounts related to the initial Ocwen Mortgage Servicing Rights that Ocwen Loan Servicing receives pursuant to the related pooling and servicing agreements, which are the agreements that govern the packaging of mortgage loans into a pool, the servicing of such mortgage loans and the terms of the mortgage-backed securities issued by the securitization trust;

 

   

the right to automatically obtain legal ownership, without any additional payment to Ocwen Loan Servicing, of each Ocwen Mortgage Servicing Right upon the receipt of the necessary third party approvals and consents (this right, together with rights described in the bullet points above, constitute the “Rights to MSRs” with respect to the initial Ocwen Mortgage Servicing Rights);

 

   

the outstanding servicing advances associated with the related pooling and servicing agreements; and

 

   

other assets related to the foregoing (collectively, the foregoing represent the “Initial Purchased Assets”).

Pursuant to a servicing advance facility, we also assumed a related match funded servicing advance financing facility from Ocwen Loan Servicing effective upon the closing of the Initial Ocwen Purchase.

At closing on March 5, 2012, we paid cash of $149.8 million to Ocwen for the estimated purchase price of the Initial Purchased Assets (net of assumed liabilities of $359.2 million), subject to certain closing adjustments. The purchase price for the Rights to MSRs was based on the value of such assets at the time we entered into the Purchase Agreement and the estimated outstanding unpaid principal balance of the underlying mortgage loans at closing. The purchase price for the associated servicing advances and other assets was equal to the net consolidated book value, which approximated fair value, as of the purchase date of all assets and liabilities of the special purpose entity (“SPE”) established in connection with the advance financing facility that owns these servicing advances. We acquired servicing advances in connection with the Initial Ocwen Purchase that are held in the SPE pursuant to the Servicing Advance Facility Agreements.

 

 

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On March 31, 2012, the Company and Ocwen, pursuant to the terms of the Purchase Agreement, agreed to a final purchase price of $138.8 million for the Initial Purchased Assets (net of assumed liabilities of $359.2 million), reflecting post-closing adjustments of $11.0 million that principally resulted from declines in match funded advances. See “The Business—Description of Purchase Agreement” and “—Description of Subservicing Agreement” for more information on the Purchase Agreement and the related Master Subservicing Agreement, respectively.

The Flow Transactions

On May 1, 2012, we completed an acquisition from Ocwen Loan Servicing, which we refer to as the “Flow One Purchase,” of Rights to MSRs and related servicing advances for a servicing portfolio of subprime and Alt-A residential mortgage loans, which we refer to as the “Flow One Purchased Assets.” The Flow One Purchase resulted in the acquisition by us of Rights to MSRs with approximately $2.9 billion in unpaid principal balance as of April 30, 2012. The characteristics of the Rights to MSRs and associated servicing advances acquired in the Flow One Purchase are substantially similar to those rights we acquired in the Initial Ocwen Purchase. The Flow One Purchased Assets were acquired pursuant to a supplement to the Purchase Agreement. The initial purchase price for the Flow One Purchase was $103.8 million. To finance the purchase price, we used $25.9 million in cash generated from our operations and borrowed $77.9 million under the Servicing Advance Facility against the $92.6 million in servicing advances associated with the Rights to MSRs. The final adjusted purchase price was $103.5 million.

On August 1, 2012, we completed an acquisition from Ocwen Loan Servicing, which we refer to as the “Flow Two Purchase,” and together with the Flow One Purchase, the “Flow Purchases” of Rights to MSRs and related servicing advances for a servicing portfolio of subprime and Alt-A residential mortgage loans, which we refer to as the “Flow Two Purchased Assets” and together with the Flow One Purchased Assets, the “Flow Purchased Assets,” and together with the Initial Purchased Assets and the Follow On Offering Assets (as defined below), the “Aggregate Purchased Assets”. The Flow Two Purchase resulted in the acquisition by us of Rights to MSRs with approximately $2.1 billion in unpaid principal balance as of July 31, 2012. The characteristics of the Rights to MSRs and associated servicing advances acquired in the Flow Two Purchase are substantially similar to those rights we acquired in the Initial Ocwen Purchase and the Flow One Purchase. The Flow Two Purchased Assets were acquired pursuant to a supplement to the Purchase Agreement. The initial purchase price for the Flow Two Purchase was $74.7 million. To finance that amount, we used $18.6 million in cash generated from our operations and borrowed $56.1 million under the Servicing Advance Facility against the $66.7 million in servicing advances associated with the Rights to MSRs. The final purchase price was $76.2 million, which reflected a $1.5 million adjustment for updated match funded advances and Notes Receivable—Rights to MSRs balances.

Follow On Offering Purchases

On September 13, 2012, we completed an acquisition from Ocwen Loan Servicing, which we refer to as the “First Follow On Offering Purchase” of Rights to MSRs and related servicing advances for a servicing portfolio of subprime and Alt-A residential mortgage loans, which we refer to as the “First Follow On Offering Assets.” The First Follow On Offering Purchase resulted in the acquisition by us of Rights to MSRs with approximately $21.1 billion in unpaid principal balance as of September 12, 2012. The characteristics of the Rights to MSRs and associated servicing advances acquired in the First Follow On Offering Purchase are substantially similar to those rights we acquired in the Initial Ocwen Purchase and the Flow Purchases. The First Follow On Offering Purchased Assets were acquired pursuant to a supplement to the Purchase Agreement. The initial purchase price for the First Follow On Offering Purchase was $793.0 million. To finance the purchase price, we used $202.5 million in proceeds from our offering of 16,387,500 newly issued ordinary shares at a price to the public of $15.25 per share, in which we received net proceeds of $236.0 million after deducting underwriting discounts and expenses (the “Follow On Offering”) and $590.5

 

 

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million in cash borrowed under the Servicing Advance Facility against the $707.5 million in servicing advances associated with the Rights to MSRs. The final purchase price was $788.2 million, which reflected a $4.8 million adjustment for revised match funded advance balances.

On September 28, 2012, we completed an acquisition from Ocwen Loan Servicing, which we refer to as the “Second Follow On Offering Purchase” and together with the First Follow On Offering Purchase, the “Follow On Offering Purchases,” of Rights to MSRs and related servicing advances for a servicing portfolio of subprime and Alt-A residential mortgage loans, which we refer to as the “Second Follow On Offering Assets” and together with the First Follow On Offering Assets, the “Follow On Offering Assets.” The Second Follow On Offering Purchase resulted in the acquisition by us of Rights to MSRs with approximately $6.7 billion in unpaid principal balance as of September 27, 2012. The characteristics of the Rights to MSRs and associated servicing advances acquired in the Second Follow On Offering Purchase are substantially similar to those rights we acquired in the Initial Ocwen Purchase, the Flow Purchases and the First Follow On Offering Purchase. The Second Follow On Offering Purchased Assets were acquired pursuant to a supplement to the Purchase Agreement. The initial purchase price for the Second Follow On Offering Purchase was $238.1 million. To finance the purchase price, we used $30.6 million of the remaining net proceeds from the Follow On Offering and borrowed $207.5 million under the Servicing Advance Facility. The final purchase price was $242.4 million, which reflected a $4.3 million adjustment for updated match funded advances and Notes Receivable—Rights to MSRs balances.

Throughout this prospectus, we refer to the Initial Ocwen Purchase, the Flow Purchases and the Follow On Offering Purchases together as the “Ocwen Transactions.” We refer to the mortgage servicing rights associated with the Ocwen Transactions as the “Acquired Mortgage Servicing Rights.”

As of September 30, 2012, the outstanding balance for the Servicing Advance Facility used to finance the Ocwen Transactions was $1,251 million with a weighted average effective interest rate of 5.01% for the quarter ended September 30, 2012. We executed a hedging strategy aimed to mitigate the impact of changes in variable interest rates on the excess of interest rate sensitive liabilities over interest rate sensitive assets. Accordingly, we entered into interest rate swaps to hedge against the effects of a change in 1-Month LIBOR, and as of September 30, 2012, we had interest rate swaps totaling a notional amount of $460 million with banks. None of the swap counterparties is Ocwen, its affiliates or affiliates of HLSS.

The Planned Acquisition

Consistent with our growth strategy, we intend to use the net proceeds of this offering to purchase additional Mortgage Servicing Assets from Ocwen Loan Servicing in a follow on purchase, which we refer to as the “Planned Acquisition.” We are in discussions with Ocwen Loan Servicing regarding the composition of the Planned Acquisition Assets (as defined below), but have not yet finalized the identification of the specific assets we will acquire. We expect the Planned Acquisition Assets will have similar characteristics to those Mortgage Servicing Assets acquired in the Ocwen Transactions, and that the related servicing advances, both current and future, will be eligible for funding under the Servicing Advance Facility Agreements.

We will pursue additional advance financing in connection with the Planned Acquisition, including increasing the borrowing size of the Servicing Advance Facility to allow for additional borrowing or entering into one or more new servicing advance facilities with one or more lenders. We have not entered into definitive agreements for either of these financing options and do not have firm commitments for additional servicing advance financing for the Planned Acquisition.

 

 

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The Planned Acquisition will be made pursuant to a supplement to the Purchase Agreement under similar terms to those supplements governing the Aggregate Purchased Assets, which provides for, among other things:

 

   

the contractual right to receive the servicing fees (excluding any ancillary income) related to any acquired mortgage servicing rights;

 

   

the contractual right to receive any investment earnings on the custodial accounts related to any acquired mortgage servicing rights that Ocwen Loan Servicing receives pursuant to the related pooling and servicing agreements;

 

   

the right to automatically obtain legal ownership, without any additional payment to Ocwen Loan Servicing, of each acquired mortgage servicing right upon the receipt of the necessary third party approvals and consents (this right, together with rights described in the bullet points above, constitute the “Rights to MSRs” with respect to any acquired mortgage servicing rights);

 

   

the outstanding servicing advances associated with the related pooling and servicing agreements; and

 

   

other assets related to the foregoing (collectively, the foregoing represent the “Planned Acquisition Assets”).

The mortgage loans underlying the Planned Acquisition Assets will be serviced by Ocwen Loan Servicing and, if and when we acquire the related Third Party Consent related to the Planned Acquisition Assets, will be subserviced by Ocwen Loan Servicing pursuant to the Subservicing Agreement under similar terms to those subservicing supplements governing the Aggregate Purchased Assets. We currently expect that the Planned Acquisition will close shortly after this offering, although we cannot assure you that the closing of the Planned Acquisition will not be delayed. The closing of this offering is not conditioned upon the closing of the Planned Acquisition.

Ocwen Loan Servicing has stated that as of September 30, 2012 it has mortgage servicing assets with approximately $63.8 billion of unpaid principal balance that are similar to the assets that HLSS has purchased in the past. In addition, in connection with Ocwen’s announced acquisition of Homeward Residential Holdings, Inc. and Ocwen Loan Servicing’s announced acquisition of certain assets of Residential Capital, LLC, Ocwen and Ocwen Loan Servicing are anticipated to acquire additional rights to service mortgage loans with approximately $120.0 billion of unpaid principal balance that are similar to those in our current portfolio.

Third Party Consents

Ocwen Loan Servicing will remain the named servicer of the Acquired Mortgage Servicing Rights and the mortgage servicing rights associated with the Planned Acquisition until such time as the approvals and consents necessary to transfer legal ownership of such acquired mortgage servicing rights to us are obtained. We expect that the approvals, consents and other documentation from third parties necessary to transfer such legal ownership will include:

 

   

statements from the rating agencies that rated the related securitization transactions (which will likely include Moody’s Investors Service, Standard & Poor’s Ratings Service and Fitch Ratings Service) that the transfer of legal ownership of the acquired mortgage servicing rights to us will not cause a downgrade of the related mortgage-backed securities;

 

   

the consent of parties to the related pooling and servicing agreements, which may include the trustees of the related securitization trusts, the sponsors of the securitization transactions, any master servicer for the securitization transactions or any bond insurers or other credit enhancers insuring the mortgage-backed securities issued by the securitization trusts; and

 

 

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any amendments to the related pooling and servicing agreements required to effectuate the transfer and sale of the related acquired mortgage servicing rights to us.

We refer to these requirements collectively as they relate to the Acquired Mortgage Servicing Rights and the mortgage servicing rights associated with the Planned Acquisition or any acquired mortgage servicing rights as the “Required Third Party Consents.”

In connection with the Initial Ocwen Purchase, one of the rating agencies from whom a rating confirmation is required prior to the transfer of legal ownership of the mortgage servicing rights to us in the Initial Ocwen Purchase stated that it would not provide such confirmation primarily because we were a newly formed entity with no demonstrated operating history as a mortgage servicer. Based on our current dialogue with this rating agency and the other consent parties, our near term goal in pursuit of such consents is to establish an operating history that demonstrates a continued capability to perform the servicing requirements, specifically our obligation to fund servicing advances and to make principal and interest remittances in conformity with all requirements of the pooling and servicing agreements. Although no specific time frame was provided by the rating agency, we believe that it will be up to at least one year from the closing of our initial public offering before the rating agency will consider issuing a rating confirmation. As of the date of this prospectus, we have not received an update from the rating agencies with respect to the timing of a rating confirmation or whether that confirmation will be forthcoming. As a result, the Initial Ocwen Purchase, the Flow Purchases and the Follow On Offering Purchases were structured as purchases of Rights to MSRs and the Planned Acquisition is expected to be structured as a purchase of Rights to MSRs. A continued strategic priority for us is to obtain the Required Third Party Consents necessary for us to become the named servicers for the securitizations where we currently own Rights to MSRs and the associated advances. We will automatically obtain legal ownership of any such mortgage servicing rights without any additional payment to Ocwen Loan Servicing if and when we obtain the Required Third Party Consents.

So long as any Required Third Party Consents have not been obtained:

 

   

Ocwen Loan Servicing will remain obligated to perform its obligations as servicer under the related pooling and servicing agreement;

 

   

we will be contractually required to purchase any servicing advances that Ocwen Loan Servicing is required to make pursuant to such pooling and servicing agreement as long as such servicing advances made by Ocwen Loan Servicing are made in accordance with its advance and stop advance policies;

 

   

Ocwen Loan Servicing will be prohibited from taking actions inconsistent with our right to acquire legal ownership of the related mortgage servicing right upon receipt of the Required Third Party Consents; and

 

   

we will account for the acquired Rights to MSRs as a financing. Accordingly, we will record the purchase price paid to Ocwen Loan Servicing as a “Notes Receivable—Rights to MSRs.” We will record the servicing fees that we receive with respect to the Rights to MSRs, net of servicing costs related to such Rights to MSRs, as payments on the note and apportion these payments between interest income and principal repayment.

If and when we obtain the Required Third Party Consents and become the legal owner of any acquired mortgage servicing right:

 

   

we will be contractually obligated to service the mortgage loans underlying such acquired mortgage servicing rights in accordance with the related pooling and servicing agreement;

 

   

Ocwen Loan Servicing will be contractually obligated to us pursuant to a subservicing agreement to perform substantially all of the servicing functions it previously performed relating to such acquired

 

 

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mortgage servicing right on our behalf, other than maintaining custodial accounts, remitting amounts from the custodial accounts and funding servicing advances pursuant to the terms of the related pooling and servicing agreement, which will be functions for which we would be responsible; and

 

   

we will account for the remaining balance of the Notes Receivable—Rights to MSRs related to such acquired mortgage servicing right as mortgage servicing rights to the extent we receive any Required Third Party Consents to transfer legal ownership of such mortgage servicing rights to us.

We cannot be certain of how long it would take to obtain any Required Third Party Consents or if we would be able to obtain them at all. We do not believe, however, that our business strategy or economic performance has been or will be materially affected by whether we own any acquired mortgage servicing rights or the related Rights to MSRs.

The Market Opportunity

We believe that the current dynamics of the subprime and Alt-A mortgage servicing market have created a unique opportunity where the supply of mortgage servicing rights potentially for sale outweighs the number of potential buyers. These dynamics include:

 

   

higher borrower delinquencies and defaults experienced over the last few years and increased regulatory oversight has led to substantially higher costs for mortgage servicers and negatively impacted their profitability;

 

   

regulatory changes resulting from the implementation of the new international bank capital adequacy framework (“Basel III”), which will impose increased regulatory capital costs on depository institutions for owning mortgage servicing rights; and

 

   

our belief that subprime and Alt-A mortgage servicing has become less attractive to many mortgage servicers due to increasingly negative publicity and heightened government and regulatory scrutiny.

We believe that our business model allows us to be highly competitive in the acquisition of Mortgage Servicing Assets due to our cost structure, ability to access advance financing and our relationship with Ocwen Loan Servicing and although we remain open to purchasing assets from third parties other than Ocwen Loan Servicing, given the large amount of servicing assets remaining at Ocwen Loan Servicing, we do not view initiating purchases from other third parties as a near-term priority. We anticipate that our acquisitions of Mortgage Servicing Assets from sellers other than Ocwen Loan Servicing may involve engaging a party other than such seller to service the underlying mortgage loans.

Competitive Strengths

We believe we are well positioned to execute our business strategy based on the following competitive strengths:

Experienced Management Team with Extensive Knowledge of the Mortgage Servicing Industry.    We have an executive management team with extensive experience in the mortgage servicing industry. This experience includes evaluating and acquiring mortgage servicing rights, performing asset valuation analysis and financing mortgage servicing businesses through a variety of economic cycles. Key members of our executive management team also have experience in managing a public company in the mortgage servicing industry.

 

 

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Asset Acquisition and Evaluation Expertise.    We believe that our asset acquisition evaluation process, which includes using proprietary historical data to project the performance of mortgage loans, and our executive management team’s experience and judgment in identifying, assessing, valuing and acquiring new Mortgage Servicing Assets enables us to accurately price assets.

Access to Mortgage Servicing Assets.    Over time, we expect to acquire substantially all of Ocwen Loan Servicing’s remaining mortgage servicing rights relating to subprime and Alt-A mortgage loans, which had an unpaid principal balance of approximately $63.8 billion as of September 30, 2012, either through flow transactions or follow on purchases depending upon our excess cash flow and access to the capital markets to obtain additional equity financing. In addition, in connection with Ocwen’s announced acquisition of Homeward Residential Holdings, Inc. and Ocwen Loan Servicing’s announced acquisition of certain assets of Residential Capital, LLC, Ocwen and Ocwen Loan Servicing are anticipated to acquire rights to service mortgage loans with approximately $120.0 billion of unpaid principal balance that are similar to those in our current portfolio. As of September 30, 2012, we had acquired Rights to MSRs with an unpaid principal balance of approximately $48.0 billion from Ocwen Loan Servicing. Future acquisitions of Ocwen Loan Servicing’s remaining mortgage servicing rights will depend on various factors, including our ability to access financing and to obtain the required third party approvals and consents, and may not take place.

Relationship with Ocwen.    We intend to continue to capitalize on the servicing capabilities of Ocwen Loan Servicing, which we view as superior relative to other servicers in terms of cost, management experience, technology infrastructure and platform scalability. Ocwen Loan Servicing will continue to service the mortgage loans underlying the Aggregate Purchased Assets, as well as service the mortgage loans underlying the Planned Acquisition Assets, during the period of time prior to the transfer of legal ownership to us of the Acquired Mortgage Servicing Rights and the mortgage servicing rights associated with the Planned Acquisition. Thereafter, we will engage Ocwen Loan Servicing to service on our behalf the mortgage loans underlying our Mortgage Servicing Assets and any additional mortgage servicing assets that we may acquire from them in the future, provided that the performance criteria specified in the Subservicing Agreement are met. We may also engage Ocwen Loan Servicing to service mortgage loans underlying any mortgage servicing assets that we acquire from other third parties in the future.

Recent Developments

On November 15, 2012, the Company announced that its Board of Directors increased the dividend for the months of November and December 2012 by $0.01 to $0.12 per ordinary share. The Company increased dividends previously declared due to increased earnings expectations, which resulted from lower than anticipated prepayments through the middle of the fourth quarter. The October prepayment rate was 13.6% despite a rebound in the number of loan modifications. With the prepayment rate likely to remain below 15% for the fourth quarter, the Company revised its earnings guidance to $0.40 to $0.41 per share. At the lower end of our guidance, this dividend increase will bring our dividend payout ratio for the full year within our targeted range of 90-100% of net income over time.

This information was prepared by, and is the responsibility of, our management. Management’s expectations regarding prepayment rates and our anticipated earnings per share for the quarter ending December 31, 2012 are based upon a number of assumptions. While this information is presented with numerical specificity and is considered reasonable, it is inherently subject to significant business, economic and competitive uncertainties. Additional information regarding the risks and uncertainties that affect our business is contained in the “Risk Factors” section beginning on page 21 of this prospectus, and the information provided in the preceding paragraph should be read in conjunction with the section entitled “Forward-Looking Statements” beginning on page 48 of this prospectus.

Management’s expectations regarding prepayment rates and our anticipated earnings per share for the quarter ending December 31, 2012 are necessarily speculative in nature, and actual results could differ

 

 

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materially, particularly if the actual prepayment rate increases significantly beyond historical levels in December 2012. If one or more of our assumptions prove incorrect, our results will differ, and such differences could be material. Accordingly, prospective purchasers should not place undue reliance on these expectations, as they should not be regarded as a representation that the anticipated results will be achieved.

Ownership, Organizational and Operating Structure

On December 1, 2010, we were incorporated as a Cayman Islands exempted company. The following diagram illustrates our corporate structure, the jurisdiction of formation and the ownership interests of our subsidiaries as of September 30, 2012.

 

LOGO

Risk Factors

We have a very limited operating history and our business model is new and relatively untested. An investment in our ordinary shares involves significant risks. Below is a summary of some of the key risk factors that you should consider in evaluating an investment in our ordinary shares. This list is not exhaustive and you should carefully read the full discussion of these risks and other risks described under “Risk Factors” beginning on page 21.

 

   

We may be unable to continue to implement our business strategy or operate our business as currently expected, including being able to obtain the Required Third Party Consents.

 

   

The assumptions underlying our business model may prove incorrect.

 

   

We will have increased risk related to our relationship with Ocwen Loan Servicing so long as it retains legal ownership of any mortgage servicing rights we may acquire from Ocwen Loan Servicing.

 

   

We may not be able to pay dividends on our ordinary shares, and our Board of Directors has the right to rescind any dividends declared, but unpaid at any time prior to the applicable dividend payment date.

 

 

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We rely on Ocwen Loan Servicing to service our entire portfolio of Purchased Assets both before legal ownership is transferred to us and after.

 

   

We will need to acquire additional Mortgage Servicing Assets to maintain and grow our business as planned.

 

   

We may not be able to obtain financing or be able to comply with our obligations under our financing arrangements to fund our servicing advances and future acquisitions of Mortgage Servicing Assets, including the Planned Acquisition.

 

   

Government regulation may adversely affect our business.

 

   

We may become subject to taxation in the United States.

 

   

Many pooling and servicing agreements for subprime and Alt-A mortgage loans contain servicer termination events or events of default based upon the percentage of delinquent loans in the related mortgage loan pool, the loss performance of the related mortgage loans or servicer ratings downgrades. Servicer termination events or events of default based on the number of delinquent mortgage loans, loss performance of the related mortgage loans or servicer ratings downgrades have been triggered in pooling and servicing agreements representing approximately 81% of the unpaid principal balance of the mortgage loans underlying the Ocwen Mortgage Servicing Rights as of June 30, 2012, although the parties to the related securitization transactions have not exercised their right to terminate Ocwen Loan Servicing as servicer.

Corporate Information

Our principal executive offices are located in the Cayman Islands c/o Intertrust Corporate Services (Cayman) Limited (formerly Walkers Corporate Services Limited), 87 Mary Street, George Town, Grand Cayman KYI-9005, Cayman Islands. We also maintain offices in the United States located at 2002 Summit Boulevard, Sixth Floor, Atlanta, Georgia 30319 and at 1661 Worthington Road, Suite 100, West Palm Beach, Florida 33409. We can be reached by telephone at (561) 682-7561, and our website is www.hlss.com. We do not incorporate information on, or accessible through, our corporate website into this prospectus, and you should not consider it a part of this prospectus.

 

 

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The Offering

 

Issuer

Home Loan Servicing Solutions, Ltd.

 

Ordinary shares offered in this offering

22,000,000 ordinary shares.

 

Underwriters’ option to purchase additional ordinary shares

We have granted the underwriters an option to purchase up to an additional 3,300,000 ordinary shares from us at the public offering price, less the underwriting discounts, for a period of 30 days from the date of this prospectus to cover the option to purchase additional shares, if any.

 

Number of ordinary shares to be outstanding after the offering

52,584,718 ordinary shares (55,884,718 ordinary shares if the underwriters’ option to purchase additional ordinary shares is exercised in full).

 

Use of proceeds

The net proceeds to us from this offering, after deducting underwriting discounts and commissions and our estimated offering expenses, will be approximately $388 million (or $447 million if the underwriters exercise their option to purchase up to an additional 3,300,000 ordinary shares) assuming a public offering price of $18.37 per share, which represents the closing price of the ordinary shares on The NASDAQ Global Select Market on December 17, 2012. We intend to use the net proceeds of this offering to acquire the Planned Acquisition Assets from Ocwen Loan Servicing in the Planned Acquisition. We are in discussions with Ocwen Loan Servicing regarding the composition of the Planned Acquisition Assets, but have not yet finalized the identification of the specific assets we will acquire. We expect the Planned Acquisition Assets will have similar characteristics to those Mortgage Servicing Assets acquired in the Ocwen Transactions, and that the related servicing advances, both current and future, will be eligible for funding under the Servicing Advance Facility Agreements. We have not entered into any agreement to acquire the Planned Acquisition Assets. The closing of the Planned Acquisition is not a condition to the closing of this offering. We intend to use the remaining net proceeds, if any, to acquire additional Mortgage Servicing Assets from Ocwen Loan Servicing or for working capital and general corporate purposes. See “Use of Proceeds.”

 

Dividend policy

We intend to distribute at least 90% of our net income over time to our shareholders in the form of a monthly cash dividend, although we are not required by law to do so.

 

 

Since the closing of our initial public offering, we paid monthly dividends of $0.10 per ordinary share through September 2012 (except during the month of March in which we paid a pro-rated amount of $0.08 per ordinary share), a dividend of $0.11 for October 2012 and a dividend of $0.12 for November 2012. On

 

 

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November 15, 2012, our Board of Directors increased the previously declared dividend for the months of November and December 2012 by $0.01 to $0.12 per ordinary share.

 

  The following table sets forth the record and payment dates of the dividend that has been declared by our Board of Directors, but is unpaid, for the month of December 2012:

 

         

Record Date

  

Payment Date

  

Amount per

Ordinary Share

    December 31, 2012    January 10, 2013    $0.12

 

  Our Board of Directors has the right to rescind any declared, but unpaid dividends at any time prior to the applicable dividend payment date. See “Dividend Policy,” “Description of Share Capital” and “Material Cayman Islands and United States Federal Income Tax Considerations.”

 

NASDAQ Global Select Market symbol

“HLSS.”

 

Tax Considerations

We expect to be treated as a PFIC for U.S. federal income tax purposes. In order to avoid possible adverse tax consequences, including deferred tax and interest charges under the U.S. Internal Revenue Code and Treasury regulations thereunder, “U.S. Holders” (as defined below under “Material Cayman Islands and United States Federal Income Tax Considerations—United States Federal Income Taxation”) may make a “qualified electing fund,” or QEF, election or a mark-to-market election with respect to their investments in our ordinary shares. U.S. Holders should consult with their tax advisors as to whether or not to make such elections and the related consequences and should carefully review the information set forth under “Material Cayman Islands and United States Federal Income Tax Considerations—United States Federal Income Taxation—Consequences to U.S. Holders—Passive Foreign Investment Company Status and Related Tax Consequences” for additional information.

 

Risk Factors

Please read “Risk Factors” beginning on page 20 of this prospectus for a discussion of the factors that you should carefully consider before deciding to invest in our ordinary shares.

Except as otherwise indicated, all information in this prospectus reflects or assumes no exercise by the underwriters of their option to purchase up to an additional 3,300,000 ordinary shares in this offering at the assumed public offering price of $18.37 per share, which represents the closing price of the ordinary shares on The NASDAQ Global Select Market on December 17, 2012.

 

 

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Summary Consolidated Financial Data

We were incorporated as a Cayman Islands exempted company on December 1, 2010. Prior to our initial public offering, our operations were limited to negotiating and entering into the Purchase Agreement and the Subservicing Agreement with Ocwen Loan Servicing, negotiating and entering into arrangements with lenders and other third parties to effect the transfer of our initial Mortgage Servicing Assets, associated servicing advances and the related match funded liabilities to us, negotiating and entering into professional and administrative services agreements with Ocwen Loan Servicing and Altisource Portfolio Solutions S.A., or “Altisource” and general corporate functions. We also entered into a stock purchase agreement pursuant to which William C. Erbey, the founder of our company and the Chairman of our Board of Directors, acquired $10.0 million of our ordinary shares at a purchase price of $14.00 per share concurrently with the closing of our initial public offering. Therefore, we have no historical financial statements reflecting our operations prior to our inception, and our audited balance sheet as of December 31, 2011 and the results of our operations for 2011 reflect only the activities described above.

The following table sets forth certain of our financial information. The consolidated financial information for the year ended December 31, 2011 has been derived from our audited consolidated financial statements included in this prospectus. The summary financial information for the three and nine month periods ended September 30, 2012 and 2011 has been derived from our unaudited consolidated financial statements included in this prospectus, which, in the opinion of management, include all adjustments (consisting of normal recurring adjustments) that are necessary for a fair presentation of our financial position and results of operations for such periods. The operating results for the nine months ended September 30, 2012 may not be indicative of the results that may be expected for the entire year.

The unaudited as adjusted balance sheet data below gives effect to the completion of this offering as if it had been completed at September 30, 2012.

The following information should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements, including the notes thereto, appearing elsewhere in this prospectus.

Servicing Advances

We value servicing advances that we make on mortgage loans at their carrying amounts because they have no scheduled maturity, generally are realized within a relatively short period of time and do not bear interest.

Notes Receivable—Rights to MSRs

We record the Notes Receivable—Rights to MSRs at the purchase price of the related Rights to MSRs (as described in the Purchase Agreement). We amortize Notes Receivable—Rights to MSRs using the prospective interest method of accounting. At each reporting date, we calculate the present value of the net cash flows related to the underlying mortgage servicing rights and adjust the carrying value of the applicable Notes Receivable—Rights to MSRs to this amount. The change in the carrying value of the Notes Receivable—Rights to MSRs reduces the interest income associated with our Notes Receivable—Rights to MSRs.

 

 

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We estimate the fair value of our Notes Receivable—Rights to MSRs by calculating the present value of expected future cash flows of the related mortgage servicing rights utilizing assumptions that we believe are reasonable and consistent with the assumptions that are used by other market participants. The most significant assumptions used are estimates of the speed at which mortgages will prepay and the aggregate principal amount of mortgage loans that will become delinquent, both of which are based on our historical experience and available market data. Other assumptions used in our valuation are:

 

•   Cost of servicing

 

•   Compensating interest expense

•   Discount rate reflecting the risk of earning future income streams from the mortgage servicing rights

 

•   Interest rate used for computing float earnings

•   Interest rate used for computing the cost of servicing advances

 

•   Collection rate of other ancillary fees

The significant components of the estimated future cash inflows for the mortgage servicing rights held by us include servicing fees, late fees, prepayment penalties and float earnings. Significant cash outflows include the cost of servicing, the cost of financing servicing advances and compensating interest payments. We consider external market-based assumptions in determining the discount rate and interest rate for the cost of financing advances, the interest rate for float earnings and the cost of servicing. The more significant assumptions used in the September 30, 2012 and December 31, 2011 valuation include mortgage loan prepayment projections ranging from 12% to 25% of the related mortgage loans’ unpaid principal balance per year (depending on loan type) averaging to a long-term projected mortgage loan prepayment rate of approximately 18% of the related mortgage loans’ unpaid principal balance per year, and delinquency rates ranging from 15% to 35% of the aggregate unpaid principal balance of mortgage loans related to the mortgage servicing rights held by us (depending on loan type). The long-term prepayment projections include voluntary and involuntary mortgage loan prepayment projections. Other assumptions include an interest rate of 1-month LIBOR plus 4% for computing the cost of financing servicing advances, an interest rate of 1-month LIBOR for computing float earnings, and discount rates ranging from 14% to 22%, which reflect the risks associated with our relationship with Ocwen Loan Servicing (which currently services all of the Purchased Assets), including the risk that Ocwen Loan Servicing could become bankrupt, insolvent or otherwise be terminated as servicer.

Match Funded Liabilities

The majority of our match funded liabilities as of September 30, 2012 bear interest at a rate that is adjusted regularly based on a market index, and thus their carrying value approximates fair value. A portion of our liabilities are fixed, and their carrying value also approximates fair value as of September 30, 2012.

 

 

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Consolidated Statement of Operations

(dollars in thousands, except ordinary share data)

(unaudited)

 

     Three Months  Ended
September 30,
    Nine Months Ended
September 30,
 
     2012      2011     2012      2011  

Revenue

          

Interest income—notes receivable—Rights to MSRs

   $ 14,017       $      $ 27,542       $   

Interest income—other

     146                283           
  

 

 

    

 

 

   

 

 

    

 

 

 

Total interest income

     14,163                27,825           

Other revenue

     669                1,664           
  

 

 

    

 

 

   

 

 

    

 

 

 

Total revenue

     14,832                29,489           
  

 

 

    

 

 

   

 

 

    

 

 

 

Operating expenses

          

Compensation and benefits

     1,257                2,682           

General and administrative expenses

     679         38        1,625         82   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total operating expenses

     1,936         38        4,307         82   
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) from operations

     12,896         (38     25,182         (82
  

 

 

    

 

 

   

 

 

    

 

 

 

Other expense

          

Interest expense

     6,252                12,507           
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other expense

     6,252                12,507           
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

     6,644         (38     12,675         (82

Income tax expense

     72                149           
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ 6,572       $ (38   $ 12,526       $ (82
  

 

 

    

 

 

   

 

 

    

 

 

 

Earnings (loss) per share

          

Basic

   $ 0.37       $ (1.90   $ 1.04       $ (4.08
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted

   $ 0.37       $ (1.90   $ 1.04       $ (4.08
  

 

 

    

 

 

   

 

 

    

 

 

 

Weighted average ordinary shares outstanding

          

Basic

     17,581,593         20,000        12,008,394         20,000   

Diluted

     17,581,593         20,000        12,008,394         20,000   

Dividends declared per share

   $ 0.34       $ 0.00      $ 0.94       $ 0.00   

 

 

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Consolidated Balance Sheet

(dollars in thousands, except ordinary share data)

(unaudited)

 

     September 30,
2012
    As adjusted
for  the
offering
 

Assets

    

Cash

   $ 33,750      $ 421,992   

Match funded advances

     1,446,091        1,446,091   

Notes receivable—Rights to MSRs

     177,730        177,730   

Other assets

     45,334        45,334   
  

 

 

   

 

 

 

Total assets

   $ 1,702,905      $ 2,091,147   
  

 

 

   

 

 

 

Liabilities and Equity

    

Liabilities

    

Match funded liabilities

   $ 1,250,912      $ 1,250,912   

Dividends payable

     3,058        3,058   

Other liabilities

     30,948        30,948   
  

 

 

   

 

 

 

Total liabilities

     1,284,918        1,284,918   
  

 

 

   

 

 

 

Commitments and Contingencies (See Note 14)

    

Equity

    

Equity—Ordinary shares, $0.01 par value; 200,000,000 shares authorized; 30,584,718 and 52,584,718 shares issued and outstanding at September 30, 2012 (unadjusted) and September 30, 2012 (adjusted), respectively

     306        526   

Additional paid-in capital

     415,155        803,177   

Retained earnings

     3,889        3,889   

Accumulated other comprehensive income (loss)

     (1,363     (1,363
  

 

 

   

 

 

 

Total equity

     417,987        806,229   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 1,702,905      $ 2,091,147   
  

 

 

   

 

 

 

 

 

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RISK FACTORS

An investment in our ordinary shares involves significant risks. We describe below the principal risks and uncertainties that we believe affect us or could affect us in the future. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we are not aware of or focused on or that we currently deem immaterial may also negatively affect our business operations. You should carefully read and consider the risks and uncertainties described below, together with all of the other information included in this prospectus, before you decide to invest in our ordinary shares. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, our ability to pay dividends in the future may be adversely affected, the value of our ordinary shares could significantly decline and you could lose all or part of your investment.

Risks Related to Our Business and Industry

We are a new company. If we are unable to implement our business strategy or operate our business as we currently expect, our operating results may be adversely affected and we may not be able to pay dividends in the future.

We commenced operations on March 5, 2012 using proceeds from our initial public offering and a concurrent private placement to our founder and Chairman of our Board of Directors to acquire mortgage servicing assets related to a portfolio with $15.2 billion of unpaid principal balance from Ocwen Loan Servicing. As of September 30, 2012, we had acquired mortgage servicing assets with an unpaid principal balance of approximately $48.0 billion. Our business model is still new and relatively untested and we may not be able to execute our business strategy as planned, which may negatively impact our financial performance and our ability to pay dividends in the future. Businesses such as ours, which are starting up or in their initial stages of development, present substantial business and financial risks and may suffer significant losses. While we have an executive management team whose members are experienced in the mortgage servicing industry, their prior experience and relationships in the industry may not be successfully transferred to our company. In addition, primarily because we do not have a demonstrated operating history as a mortgage servicer, we have been unable to obtain all of the Required Third Party Consents necessary to transfer legal ownership of the Aggregate Purchased Assets to us at this time and may be unable to obtain all of the Required Third Party Consents necessary to transfer legal ownership of Planned Acquisition Assets to us. Our untested business model and limited operating history may also make it more difficult for us to acquire additional mortgage servicing rights from Ocwen Loan Servicing or other third parties in the future. As a new company we also must establish operating procedures, implement new systems and complete other tasks necessary to conduct our intended business activities.

We have not entered into any agreement to acquire the Planned Acquisition Assets and our ability to do so will depend on a number of factors, including access to adequate financing and the completion of this offering. The success of our business strategy depends, in large part, on our ability to acquire additional mortgage servicing assets. The completion of this offering is not conditioned upon completion of the Planned Acquisition. If the offering is completed and we are not able to complete the Planned Acquisition without delay or at all, our operating results could be adversely affected.

Because we are a newly formed company, the historical financial and operating data presented in this prospectus may not be representative of our future results.

We are a new company and have limited historical operating results. The quarter ended September 30, 2012 was our second full quarter of operations. In preparing our business and economic model, we made a number of assumptions about future revenues, expenses, assets and liabilities relating to the Aggregate Purchased Assets. We based these assumptions, in part, on the historical financial and operating data relating to the Aggregate Purchased Assets while they were owned by Ocwen Loan Servicing and the prior owners of the Aggregate Purchased Assets, which may not be indicative of the results we will be able to

 

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achieve in the future. Historical financial performance should not be considered a reliable indicator of future performance, and historical trends may not be reliable indicators of anticipated financial performance or trends in future periods. If our assumptions prove incorrect, we may be unable to pay dividends in the future.

We may not be able to obtain the Required Third Party Consents necessary to transfer legal ownership of any acquired mortgage servicing rights to us.

Generally, most pooling and servicing agreements require the consent of various parties, including the rating agencies, the trustees of the related securitization trusts, the sponsors of the securitization transactions, any master servicer or any bond insurers or other credit enhancers insuring the mortgage-backed securities issued by the securitization trusts, prior to the transfer of legal ownership of the related mortgage servicing rights. In connection with the Initial Ocwen Purchase, some but not all of the rating agencies indicated that they would issue a statement that the transfer to us of legal ownership of the mortgage servicing rights purchased would not result in a downgrade to the rating of the related mortgage-backed securities. Additionally, we have not received all of the other Required Third Party Consents in connection with mortgage servicing rights purchased by us. Based on our current dialogue with consent parties, our near term goal in pursuit of such consents is to establish an operating history that demonstrates a continued capability to perform the servicing requirements, specifically our obligation to fund servicing advances and to make principal and interest remittances in conformity with all requirements of the pooling and servicing agreements. Until we obtain the Required Third Party Consents necessary to transfer legal ownership of a mortgage servicing right to us, Ocwen Loan Servicing will retain legal ownership of such mortgage servicing right. Although we are pursuing, and will continue to pursue, the Required Third Party Consents together with Ocwen Loan Servicing, we may not be able to obtain all the Required Third Party Consents in a timely manner or at all. Our understanding of one of the primary issues related to obtaining the Required Third Party Consents is that one of the rating agencies would not provide confirmation of its rating of the related mortgage-backed securities, at least until such time as we have developed an operating history as a mortgage servicer. Although no specific time frame was provided by the rating agency, we believe that it will be up to at least one year from the closing of our initial public offering before the rating agency will consider issuing a rating confirmation. We have not received an update from rating agencies with respect to the timing of a rating confirmation or whether that confirmation will be forthcoming. Until we receive the Required Third Party Consents and legal ownership of the mortgage servicing rights is transferred to us, we are subject to increased risks as a result of Ocwen Loan Servicing continuing to own the mortgage servicing rights, including the risks relating to the potential of Ocwen Loan Servicing filing for bankruptcy or being terminated as servicer. See below under “—A bankruptcy of Ocwen Loan Servicing could adversely affect our business, expected dividends on our ordinary shares and the value of your investment in us.”

A bankruptcy of Ocwen Loan Servicing could adversely affect our business, expected dividends on our ordinary shares and the value of your investment in us.

If Ocwen Loan Servicing becomes subject to a bankruptcy proceeding, our business could be materially adversely affected, and you could suffer losses.

The validity or priority of our security interest in the Acquired Mortgage Servicing Rights could be challenged in a bankruptcy proceeding of Ocwen Loan Servicing, and the Purchase Agreement could be rejected in such proceeding.    Ocwen Loan Servicing’s obligations under the Purchase Agreement with respect to the Rights to MSRs is secured by a security interest in the related Acquired Mortgage Servicing Rights and the proceeds of the related Acquired Mortgage Servicing Rights. We have undertaken all requirements under applicable law to properly create and perfect such a security interest with respect to the Rights to MSRs that we have purchased to date, including pledging the collateral in the Purchase Agreement and filing financing statements in appropriate jurisdictions, and will undertake to properly create and perfect security interests in any additional Rights to MSRs that we may purchase from Ocwen Loan Servicing in the future, including in the Planned Acquisition. Nonetheless, our security interest may

 

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be ruled unenforceable or ineffective by a bankruptcy court. If Ocwen Loan Servicing were to file, or to become the subject of, a bankruptcy proceeding under the United States Bankruptcy Code or similar state insolvency laws, during the period of time prior to the transfer of the Acquired Mortgage Servicing Rights to us, Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee could reject the Purchase Agreement and attempt to stop payments to us of the servicing or other related fees with respect to the Rights to MSRs and terminate our right to acquire those Acquired Mortgage Servicing Rights that we have not already acquired. In the event the security interest is declared unenforceable or ineffective, we would be subject to the risk that our claim for any damages from the rejection of the Purchase Agreement or the failure to pay us the servicing or other related fees with respect to the Rights to MSRs would be treated as a general unsecured claim for purposes of distributions from Ocwen Loan Servicing’s bankruptcy estate. In addition, even if the security interest is found to be valid and enforceable, if a bankruptcy court determines that the value of the collateral exceeds the underlying obligation to us, then Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee would have the power (with the approval of the bankruptcy court) to modify the terms of the payment obligations to us, to substitute collateral securing the security interest or to reduce the collateral securing the security interest to a lesser amount deemed “adequate” to secure payment of our claim.

Payments made by Ocwen Loan Servicing to us could be avoided by a court under federal or state preference laws.    If Ocwen Loan Servicing were to file, or to become the subject of, a bankruptcy proceeding under the United States Bankruptcy Code or similar state insolvency laws and our security interest is declared unenforceable or ineffective, payments previously made by Ocwen Loan Servicing to us pursuant to the Purchase Agreement may be recoverable on behalf of the bankruptcy estate as preferential transfers. A payment could constitute a preferential transfer if a court were to find that the payment was a transfer of an interest of property of Ocwen Loan Servicing that:

 

   

was made to or for the benefit of a creditor;

 

   

was for or on account of an antecedent debt owed by Ocwen Loan Servicing before that transfer was made;

 

   

was made while Ocwen Loan Servicing was insolvent (a company is presumed to have been insolvent on and during the 90 days preceding the date the company’s bankruptcy petition was filed);

 

   

was made on or within 90 days (or if we are determined to be a statutory insider, on or within one year) before Ocwen Loan Servicing’s bankruptcy filing; and

 

   

permitted us to receive more than we would have received in a Chapter 7 liquidation case under applicable bankruptcy laws.

If the court were to determine that any payments were avoidable as preferential transfers, we would be required to return such payments to Ocwen Loan Servicing’s bankruptcy estate.

A sale of Mortgage Servicing Assets or other assets could be re-characterized as a pledge of such assets in a bankruptcy proceeding.    If Ocwen Loan Servicing’s transfer to us of Mortgage Servicing Assets or any other asset transferred pursuant to the Purchase Agreement were considered to be a sale of such assets, then such assets would not be part of Ocwen Loan Servicing’s bankruptcy estate. Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee might assert in a bankruptcy proceeding, however, that mortgage servicing rights or any other asset transferred to us pursuant to the Purchase Agreement were not sold to us but were merely pledged to us as security for Ocwen Loan Servicing’s obligation to repay amounts paid by us to Ocwen Loan Servicing pursuant to the Purchase Agreement. If such assertion were successful, all or part of the Mortgage Servicing Assets or any other asset transferred to us pursuant to the Purchase Agreement would constitute property of the bankruptcy estate of Ocwen Loan Servicing, and our rights against Ocwen Loan Servicing would be those of a secured creditor, and not those of an owner, of such assets. Although we will take steps to properly create and perfect a security interest in the assets we have purchased or may purchase in the future

 

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pursuant to the Purchase Agreement in case such purchase is re-characterized as a secured financing, the validity or priority of the security interest could be challenged. See above under “—The validity or priority of our security interest in the Acquired Mortgage Servicing Rights could be challenged in a bankruptcy proceeding of Ocwen Loan Servicing, and the Purchase Agreement could be rejected in such proceeding” for a description of the risks associated with such security interest.

Payments made to us by Ocwen Loan Servicing, or obligations incurred by it, could be avoided by a court under federal or state fraudulent conveyance laws.    Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee could also attempt to claim that a sale of Rights to MSRs or sale of mortgage servicing rights or other assets by Ocwen Loan Servicing to us was a fraudulent conveyance. Under the United States Bankruptcy Code and similar state insolvency laws, payments made, or obligations incurred, could be voided if Ocwen Loan Servicing, at the time it made such payment or incurred such obligation: (a) received less than reasonably equivalent value or fair consideration for such transfer or incurrence; and (b) either (i) was insolvent at the time of, or was rendered insolvent by reason of, such transfer or incurrence; (ii) was engaged in, or was about to engage in, a business or transaction for which the assets remaining with Ocwen Loan Servicing were an unreasonably small capital; or (iii) intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature. If any transfer or incurrence is determined to be a fraudulent conveyance, Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee would be entitled to recover such transfer or to avoid the obligation previously incurred.

The Subservicing Agreement could be rejected in a bankruptcy proceeding.    If Ocwen Loan Servicing were to file, or to become the subject of, a bankruptcy proceeding under the United States Bankruptcy Code or similar state insolvency laws, Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee could reject the Subservicing Agreement and terminate Ocwen Loan Servicing’s obligation to service the mortgage loans underlying one or more of the mortgage servicing rights that we have acquired and that Ocwen Loan Servicing has agreed to service for us pursuant to the Subservicing Agreement. As we will not have and in the future do not expect to have the employees, servicing platforms or technical resources necessary to service mortgage loans, if the Subservicing Agreement is rejected we will need to either engage an alternate subservicer, which may not be readily available on acceptable terms or at all, or negotiate a new servicing arrangement with Ocwen Loan Servicing, which would presumably be on less favorable terms to us. Any claim we have for damages arising from the rejection of the Subservicing Agreement would be treated as a general unsecured claim for purposes of distributions from Ocwen Loan Servicing’s bankruptcy estate.

Any of the foregoing events might have a material adverse effect on our financial condition or operating results and our ability to pay dividends, which could cause delays or reductions in payments on our ordinary shares or a reduction in the value of our ordinary shares.

We may not be able to pay dividends on our ordinary shares.

We intend to declare and pay regular cash dividends on our ordinary shares. We intend to distribute at least 90% of our net income over time to our shareholders on a monthly basis, although we are not required by law to do so. Since the closing of our initial public offering, we paid monthly dividends of $0.10 per ordinary share through September 2012 (except during the month of March in which we paid a pro-rated amount of $0.08 per ordinary share), a dividend of $0.11 for October 2012 and a dividend of $0.12 for November 2012. On November 15, 2012, our Board of Directors increased the previously declared dividend for the months of November and December 2012 by $0.01 to $0.12 per ordinary share. The following table sets forth the record and payment dates of the dividend that has been declared by our Board of Directors, but is unpaid, for the month of December 2012:

 

Record Date

   Payment Date    Amount per Ordinary Share  

December 31, 2012

   January 10, 2013    $  0.12   

 

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Our Board of Directors has the right to rescind any declared, but unpaid dividends at any time prior to the applicable dividend payment date. See “Dividend Policy,” “Description of Share Capital” and “Material Cayman Islands and United States Federal Income Tax Considerations.”

While we intend to continue to pay monthly dividends at this rate, we may not be able to do so in the future. Our dividend policy is subject to the discretion of our Board of Directors and will depend, among other things, on cash available for distributions, general economic and business conditions, our strategic plans and prospects, our financial results and condition, contractual, legal and regulatory restrictions on the declaration and payment of dividends by us and such other factors as our Board of Directors considers to be relevant.

Our ability to declare and pay dividends is dependent on cash flow generated by our subsidiaries because we are a holding company.

We are a holding company with no operations. Our subsidiaries own all of the assets that generate income and are expected to own any additional assets we purchase in the future. Therefore, our ability to declare and pay dividends is dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us, by dividend, distribution or otherwise. Our subsidiaries may not be able or permitted to make distributions to enable us to make dividend payments in respect of our ordinary shares. Each of our subsidiaries is a distinct legal entity formed and governed under the laws of the State of Delaware, and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from them. The subsidiary that holds the Mortgage Servicing Assets and that will hold any additional Mortgage Servicing Assets we may acquire in the future, is a Delaware limited liability company. Delaware law provides that a limited liability company is prohibited from making a distribution of cash or other property to a member to the extent that, at the time of and after giving effect to the distribution, the limited liability company’s liabilities exceed the fair value of its assets, subject to certain exceptions. In addition, while our subsidiaries currently are not subject to any contractual restrictions with respect to the payment of dividends, any future financing or other arrangements that our subsidiaries enter into could limit their ability to make distributions to us. In the event that we do not receive distributions from our subsidiaries, we may be unable to make dividend payments on our ordinary shares.

We are highly dependent upon our senior management team.

Our business model and the execution of our business strategy is highly dependent upon the members of our senior management team. The loss of the services of any of our senior executives or key employees could delay or prevent us from executing our business strategy and could significantly and negatively affect our business.

Our senior management team will also devote a portion of its time to performing certain functions for Ocwen pursuant to the professional services agreement that we entered into with Ocwen, which we refer to as the “Ocwen Professional Services Agreement” throughout this prospectus. This will detract from the amount of time these executives have available to focus on our business.

In the future, we may need to hire additional personnel to meet the demands of our business, including any changes to our business strategy or operations due to a failure to obtain consents needed to transfer mortgage security rights on a timely basis or at all. The number of available, qualified personnel in the mortgage servicing industry may be limited, and the lack of qualified personnel may delay our ability to execute our business model as planned.

 

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The continued economic slowdown and/or continued deterioration of the housing market could increase delinquencies and defaults on the mortgage loans underlying the mortgage servicing rights we acquire, which would negatively affect our operating results.

The residential mortgage market in the United States has experienced and may continue to experience a variety of difficulties and challenging economic conditions. Housing prices in many parts of the United States have declined or stopped appreciating after extended periods of significant appreciation. Any further deterioration of the U.S. housing market and declines in home prices could result in increased delinquencies or defaults on the mortgage loans underlying the mortgage servicing rights we acquire.

During any period in which the borrower is not making payments on a mortgage loan, the servicer under substantially all pooling and servicing agreements is required to advance its funds to meet contractual principal and interest remittance requirements for the securitization trust that owns the mortgage loans, pay property taxes and insurance premiums, process foreclosures and maintain, repair and market foreclosed real estate properties.

If the economy slows and/or the housing market continues to deteriorate, our operating results would be adversely affected in the following ways:

Interest Income and Servicing Fee Revenue.    Because we will recognize interest income and, if and when legal title to any mortgage servicing right is transferred to us, servicing fee revenue as principal and interest payments are collected from the borrowers on the mortgage loans underlying our Mortgage Servicing Assets and as delinquent loans are resolved, an increase in delinquencies would reduce the interest income and servicing fee revenue that we recognize.

Expenses.    An increase in servicing advances outstanding relative to the amount of the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets could result in substantial strain on our financial resources because growth of outstanding servicing advances relative to the unpaid principal balance of mortgage loans would increase financing costs with no offsetting increase in interest income or servicing fee revenue, thus reducing profitability. If servicing advances increase to a level where we are unable to fund additional servicing advances, we may not be able to fulfill our obligations under the Purchase Agreement to purchase the servicing advances that Ocwen Loan Servicing is required to make pursuant to the pooling and servicing agreements related to the Acquired Mortgage Servicing Rights, or our obligations to fund servicing advances under those pooling and servicing agreements for which we are the servicer. As a result, the Purchase Agreement could be terminated, and we could lose the interest income or servicing fee revenue associated with our Rights to MSRs or be terminated as servicer under any affected pooling and servicing agreements and lose the interest income or servicing fee revenue associated with the mortgage servicing rights, as applicable.

Valuation of Mortgage Servicing Assets.    Defaults on mortgage loans will decrease the value of the associated notes receivable and Mortgage Servicing Assets. In addition, future default rates that exceed current estimates may result in higher amortization and a reduction in the value of our Mortgage Servicing Assets such that interest income or servicing fee revenue may decline and amortization and interest expense may increase.

A significant increase in prepayment speeds would reduce the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets and could adversely affect our operating results.

Prepayment speeds significantly affect our business. Prepayment speed is the measurement of how quickly borrowers pay down the unpaid principal balance of their loans or how quickly loans are otherwise brought current, modified, liquidated or charged off. Prepayment speeds, which are presently driven primarily by involuntary liquidations of subprime and Alt-A mortgage loans, have a significant impact on our servicing fees, our expenses and the valuation of our Mortgage Servicing Assets as follows:

Servicing Fees.    If prepayment speeds increase, our servicing fees will decline more rapidly than estimated because of the greater than expected decrease in the unpaid principal balance of the mortgage loans on which servicing fees are based.

 

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Expenses.    Amortization of Mortgage Servicing Assets will be our largest operating expense. Since we amortize Mortgage Servicing Assets in proportion to total expected income over the life of the Mortgage Servicing Assets, an increase in prepayment speeds will lead to increased amortization expense as we revise downward our estimate of total expected income.

Valuation of Mortgage Servicing Assets.    We base the price we pay for Mortgage Servicing Assets and the rate of amortization of those assets on, among other things, our projection of the cash flows from the related pool of mortgage loans. Our expectation of prepayment speeds is a significant assumption underlying those cash flow projections. If prepayment speeds are significantly greater than expected, the carrying value of our Mortgage Servicing Assets could exceed their estimated fair value. If the carrying value of our Mortgage Servicing Assets exceeds their fair value, we will be required to record a non-cash charge for impairment or unrealized loss, which would have a negative impact on our operating results.

If we are unable to maintain the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets at an adequate level through the acquisition of additional Mortgage Servicing Assets or otherwise, we would likely reevaluate our long-term business strategy if such conditions persist for a period of approximately five years after the date of our initial public offering. One possible outcome of this evaluation would be to sell our remaining Mortgage Servicing Assets some time thereafter and use the proceeds to pay a liquidating distribution to our shareholders. In any such event, our shareholders may not be able to recover the full value of their investment in our ordinary shares.

We may not be able to successfully compete for the acquisition of mortgage servicing rights, which could adversely affect our business.

Our success depends, in large part, on our ability to acquire additional mortgage servicing rights on terms consistent with our business and economic model. We expect to compete with independent mortgage loan servicers, private equity firms, hedge funds and other large financial services companies in acquiring additional mortgage servicing rights. Many of our anticipated competitors are significantly larger than we are, have access to greater capital and other resources, are capable of financing servicing advances at a lower interest rate and may have other advantages over us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could lead them to offer higher prices than we would be willing to pay for these assets.

Under most pooling and servicing agreements the approval or consent of third parties will be required to transfer mortgage servicing rights to us. We have not yet been able to obtain all the Required Third Party Consents necessary to transfer legal ownership of the Acquired Mortgage Servicing Rights to us, primarily because we do not have a demonstrated operating history as a mortgage servicer. No specific time frame was provided by the rating agency that has not provided consent. Although no specific time frame was provided by the rating agency, we believe that it will be up to at least one year from the closing of our initial public offering before the rating agency will consider issuing a rating confirmation. Until such time as we establish an operating history as a mortgage servicer, we may need to continue to structure purchases of mortgage servicing assets as purchases of Rights to MSRs to the extent that the related pooling and servicing agreements require approvals or consents that we are unable to obtain. As a result, other potential purchasers of mortgage servicing rights may be more attractive to sellers if the sellers believe that they can obtain any necessary third party approvals and consents to transfer the mortgage servicing rights to these potential purchasers more easily than if they were transferring them to us. Even if other potential purchasers are not viewed by sellers to be a more attractive alternative, sellers may request a higher purchase price from us if we are not able to obtain the necessary approvals and consents prior to the completion of the sale of mortgage servicing rights. This may negatively affect our ability to acquire additional mortgage servicing rights or limit the available mortgage servicing rights or types of mortgage servicing rights that we are able to offer to acquire.

We also do not intend to build a mortgage servicing platform. Therefore, we may not be an attractive buyer for those sellers of mortgage servicing rights that prefer to sell mortgage servicing rights and their mortgage servicing platform in a single transaction. Since our business model does not currently include

 

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acquiring and running servicing platforms, to engage in a bid for such a business we would need to find a partner to acquire and run the platform or we would need to incur additional costs to shut down the acquired servicing platform. The need to work with a partner in these situations increases the complexity of such potential acquisitions, and Ocwen Loan Servicing may be unwilling to act as servicer or subservicer on any mortgage servicing rights acquisition we want to execute. The complexity of these transactions and the additional costs incurred by us if we were to execute future acquisitions of this type could adversely affect our future operating results.

We may be unable to maintain the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets at an adequate level, which may cause administrative expenses to increase relative to our equity base.

The unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets will decline naturally over time. In addition, the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets could be reduced in connection with any loan put-backs. A loan put-back is a request by the securitization trustee for the originator of the loan or the party that transferred the loan to the securitization to repurchase the loan at par. These requests generally arise because the originator or transferor is found to have breached representations or warranties made at the time of origination or securitization. We have acquired additional Mortgage Servicing Assets in flow purchases in order to maintain a sufficient level of unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets relative to the size of our operations, and intend to continue to acquire additional Mortgage Servicing Assets in the future either through flow purchases or follow on purchases such as the Planned Acquisition. Given competition in our industry for the acquisition of mortgage servicing rights and the continued decrease in new securitizations, primarily as a result of the lack of new originations of subprime and Alt-A mortgage loans, a sufficient number of subprime and Alt-A mortgage servicing rights may not be available at attractive prices or at all. If we are unable to acquire new Mortgage Servicing Assets, the amount of servicing fees we receive, which is based on the unpaid principal balance of the loans underlying our Mortgage Servicing Assets, may decline as mortgage loans are repaid or liquidated. As a result, our future expenses may increase disproportionately to the size of our equity base, which will negatively affect our profitability and may limit our ability to pay dividends in the future. If we are unable to continue to make additional acquisitions of mortgage servicing rights within a period of approximately five years, we would likely reevaluate our long-term business strategy at such time. One possible outcome of this evaluation would be to sell our remaining Mortgage Servicing Assets some time thereafter and use the proceeds to pay a liquidating distribution to our shareholders. In any such event, our shareholders may not be able to recover the full value of their investment in our ordinary shares.

Our assumptions in determining the purchase price for Mortgage Servicing Assets may be inaccurate or the basis for such assumptions may change, which could adversely affect our results of operations.

To the extent that we purchase Mortgage Servicing Assets in the future, our success will be highly dependent upon accurate pricing of such Mortgage Servicing Assets. In determining the purchase price for Mortgage Servicing Assets, we will make assumptions regarding the following:

 

   

the rates of prepayment and repayment of the underlying mortgage loans;

 

   

amount of future servicing advances;

 

   

projected rates of delinquencies and defaults;

 

   

future interest rates; and

 

   

the costs associated with engaging subservicers to service the loans.

If any of our assumptions regarding the Mortgage Servicing Assets that we acquire are inaccurate or the basis for such assumptions change, the price we pay to acquire Mortgage Servicing Assets may prove to be too high. This could result in lower than expected profitability or a loss. We do not intend to obtain an opinion from an independent valuation firm of the fairness from a financial point of view of the price of any future acquisitions, including the Planned Acquisition.

 

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We do not intend to operate a mortgage servicing platform and will need to engage subservicers to service the mortgage loans underlying any mortgage servicing rights we ultimately acquire. We may not be able to engage subservicers on terms that are favorable to us or at all.

We do not intend to operate a mortgage servicing platform. Our success will depend on our ability to enter into subservicing agreements with high-quality mortgage servicers, like Ocwen Loan Servicing, to service the mortgage loans underlying any mortgage servicing rights we ultimately acquire.

The terms of any subservicing agreement will be negotiated with the subservicer prior to the acquisition of the related mortgage servicing rights. It is unlikely that the term of any subservicing agreement we enter into will match the life of any mortgage servicing rights that we ultimately acquire and therefore will need to be renewed. As a result, the terms of any new subservicing agreement or renewal will depend on the economic environment and the costs of providing subservicing at that time. For example, the initial term of the Subservicing Agreement will expire on March 5, 2018. Therefore, we will need to renegotiate the terms of this agreement before these assets wind down. In addition, the terms of any future subservicing agreements, including those we enter into with Ocwen Loan Servicing, may not be similar to the terms of the Subservicing Agreement.

We may be unable to obtain sufficient capital or obtain or maintain the servicer advance financing necessary to meet the financing requirements of our business, which could adversely affect our operating results and our ability to pay dividends in the future.

We will need access to capital to finance servicing advances relating to our Mortgage Servicing Assets we may acquire and to fund future acquisitions of additional Mortgage Servicing Assets and associated servicing advances, including the Planned Acquisition.

Servicing Advances.    If delinquencies increase with respect to the mortgage loans underlying our Mortgage Servicing Assets, we will require more funding than we currently expect, which may not be available to us on favorable terms or at all. We currently meet our servicing advance financing requirements through the Servicing Advance Facility. In order to meet our servicing advance financing requirements with respect to the Planned Acquisition Assets, we may need to obtain additional advance financing. Under normal market conditions, mortgage servicers typically have been able to renew or refinance liquidity facilities for mortgage servicing rights. However, during the economic crisis that began in 2007, there were periods of time when mortgage servicers were unable to renew these facilities. Borrowing conditions have improved since that time; however, market conditions at the time of any renewal or refinancing may not enable us to renew or refinance our advance financing facilities or obtain additional facilities on favorable terms or at all. Ocwen Loan Servicing will not have any obligation to us to fund any servicing advances that we are required to purchase or fund. Our inability to obtain adequate financing to fund servicing advances would result in the termination of our mortgage servicing rights under the applicable pooling and servicing agreements or the loss of our Rights to MSRs pursuant to the Purchase Agreement, as applicable. If, for this reason, our mortgage servicing rights or Rights to MSRs are terminated or lost, as applicable, we will bear the full economic impact of this termination or loss without the right to seek indemnification from Ocwen Loan Servicing.

Mortgage Servicing Assets.    The unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets will decline naturally over time, and we intend to acquire new Mortgage Servicing Assets to maintain the scale of our operations. To maintain our goal of distributing at least 90% of our net income over time to our shareholders on a monthly basis, we will limit the amount of unused cash and borrowing capacity. This means that we will continue to need access to the capital markets to fund acquisitions of additional Mortgage Servicing Assets and associated servicing advances. The global capital markets are currently experiencing a period of disruption and instability that began in 2007 and that has most recently resulted in the downgrading of government debt in several European States. Our ability to fund future acquisitions may depend on our ability to access the capital markets and on the strength and performance of these markets. In addition, the provisions of our Articles of Association restrict our ability

 

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to issue and sell additional ordinary shares at a price below our then current net asset value per share without first obtaining the prior approval of holders of at least a majority of the outstanding ordinary shares voted with respect to such approval. This restriction may make it more difficult for us to raise capital through the issuance of additional ordinary shares.

Ocwen Loan Servicing or we may be terminated as servicer under a pooling and servicing agreement. Servicer termination events or events of default have been triggered in pooling and servicing agreements representing approximately 81% of the unpaid principal balance of the mortgage loans underlying the Acquired Mortgage Servicing Rights as of June 30, 2012, and the parties to the related securitization transactions could enforce their rights against Ocwen Loan Servicing or us at any time as a result.

Ocwen Loan Servicing will remain obligated to service the mortgage loans underlying the Rights to MSRs that we acquire in accordance with the terms of the related pooling and servicing agreements during the period of time prior to the transfer of the Acquired Mortgage Servicing Rights to us. If and when we acquire legal ownership of the Acquired Mortgage Servicing Rights, we will be obligated to service these mortgage loans in accordance with the terms of the related pooling and servicing agreements. We will also be obligated to service the mortgage loans relating to any other mortgage servicing rights that we may acquire in the future. Pursuant to the Subservicing Agreement, we have engaged Ocwen Loan Servicing to service the mortgage loans underlying the Acquired Mortgage Servicing Rights upon our receipt of the Required Third Party Consents, and may engage Ocwen Loan Servicing or other subservicers to service the mortgage loans underlying any other mortgage servicing rights that we acquire in the future. We intend to engage Ocwen Loan Servicing to service the mortgage loans underlying the Planned Acquisition Assets. Any default by Ocwen Loan Servicing relating to its obligations as servicer under any pooling and servicing agreement related to the Acquired Mortgage Servicing Rights during the period of time prior to the transfer of the Acquired Mortgage Servicing Rights to us, or as subservicer pursuant to the Subservicing Agreement following any such transfer, or the failure of any other servicer to perform its obligations or to satisfy the other requirements under the terms of the pooling and servicing agreement related to any of our mortgage servicing rights, could result in a servicer termination event or servicer event of default under such agreement. In addition, if we fail to perform any of our obligations as servicer with respect to our mortgage servicing rights that we did not delegate to a subservicer, such as making servicing advances or remitting funds to the securitization trust in accordance with the terms of the applicable pooling and servicing agreement, it will result in a servicer termination event or servicer event of default. If we fail to purchase the servicing advances that Ocwen Loan Servicing is required to make pursuant to the related pooling and servicing agreements prior to the transfer of such Acquired Mortgage Servicing Rights to us, Ocwen Loan Servicing may be in breach of its obligations to make such servicing advances, which will also result in a servicer termination event or servicer event of default. If such servicer termination event or servicer event of default is a result of our breach of a representation under the Purchase Agreement, or our actions or our failure to act, we could owe an indemnification payment to Ocwen Loan Servicing for the amount of its losses resulting from such servicer termination event or servicer event of default.

Many pooling and servicing agreements for subprime and Alt-A mortgage loans also contain servicer termination events or events of default based upon the number of delinquent loans or the loss performance of the related mortgage loans. We believe that these servicer termination events or events of default have been triggered in most pooling and servicing agreements for subprime and Alt-A mortgage loans that were entered into prior to 2008. A significant number of the pooling and servicing agreements related to the Acquired Mortgage Servicing Rights (representing approximately 81% of the unpaid principal balance of the mortgage loans underlying such Acquired Mortgage Servicing Rights as of June 30, 2012) contain servicer termination events or events of default of this type, all of which have been triggered. We expect that a significant number of the pooling and servicing agreements related to the mortgage servicing assets that we intend to acquire in the Planned Acquisition will also contain servicer termination events or events of default that have been triggered. We believe that one possible reason that the parties to pooling and servicing agreements that have the right to terminate a servicer upon the occurrence of such servicer

 

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termination events or events of default have not exercised such rights may be because the transfer of servicing could lead to a disruption of servicing activities which could lead to increased delinquencies and decreased recovery on the underlying mortgage loans, which could result in a loss on the related mortgage-backed securities. While the parties to the securitization transactions have not exercised their right to terminate Ocwen Loan Servicing as servicer under the pooling and servicing agreements related to the Acquired Mortgage Servicing Rights, they could enforce their rights against Ocwen Loan Servicing prior to the transfer of such Acquired Mortgage Servicing Rights to us, or against us if and when we acquire the Acquired Mortgage Servicing Rights at a later date. In addition, most of the pooling and servicing agreements related to the Acquired Mortgage Servicing Rights also contain servicer termination events or events of default that require the servicer to maintain a tangible net worth of between $15 million and $50 million, and we expect the pooling and servicing agreements related to the mortgage servicing assets acquired in the Planned Acquisition to have similar terms.

If a servicer termination event or event of default has occurred under a pooling and servicing agreement, the servicer may be terminated without any right to compensation for its loss from the trustee for the securitization trust, other than the right to be reimbursed for any outstanding servicing advances as the related loans are brought current, modified, liquidated or charged off. So long as we are in compliance with our obligations under the Subservicing Agreement and the Purchase Agreement, if Ocwen Loan Servicing is terminated as servicer, or if we are terminated as servicer when Ocwen Loan Servicing is acting as subservicer, we will have the right to receive an indemnification payment from Ocwen Loan Servicing as servicer or subservicer, even if such termination related to servicer termination events or events of default existing at the time of an Ocwen Transaction, including with respect to those servicer termination events or events of default that have been triggered in pooling and servicing agreements representing approximately 81% of the unpaid principal balance of the mortgage loans underlying the Acquired Mortgage Servicing Rights as of June 30, 2012. See “—A downgrade in Ocwen Loan Servicing’s servicer rating and that of any future subservicer with whom we enter into subservicing agreements could have an adverse effect on our business, financial condition or results of operations.” If Ocwen Loan Servicing or we are terminated as servicer with respect to a pooling and servicing agreement and Ocwen Loan Servicing is unable to make any resulting indemnification payments to us, if any, it may have a material adverse effect on our operating results and our ability to pay dividends and may make it more difficult for us to acquire additional mortgage servicing rights in the future.

If our assumptions regarding subprime and Alt-A borrower refinancing options in a declining interest rate environment prove incorrect, the unpaid principal balance of the mortgage loans underlying Mortgage Servicing Assets could decline, which would adversely affect our operating results.

In preparing our business and economic model, we made a number of assumptions about future servicing fees, expenses, assets and liabilities relating to our Mortgage Servicing Assets. In connection with this process, we made certain assumptions about likely prepayment speeds on the mortgage loans underlying our Mortgage Servicing Assets in a declining interest rate environment. These assumptions were based on our view that subprime and Alt-A borrowers would have limited refinancing options even in such an environment. Refinancings, also known as voluntary prepayments, are a small component of total prepayments, with involuntary prepayments and liquidations being the larger component. If subprime and Alt-A borrowers were able to refinance their mortgage loans in a declining interest rate environment, prepayment speeds would increase, leading to lower unpaid principal balance on the mortgage loans underlying our Mortgage Servicing Assets, which would adversely affect our operating results.

 

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If our assumptions regarding the rates at which delinquent mortgage loans will become performing or be resolved through loan modifications are higher than the actual rates, then the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets will decline more quickly than we have anticipated, and the amount and duration of outstanding servicing advances would increase, which would adversely affect our operating results.

In preparing our business plan and economic model, we made assumptions about the likely delinquency rates for the mortgage loans underlying our Mortgage Servicing Assets, and the rates at which those delinquent mortgage loans would re-perform, either through a payment of past due amounts or through permitted modifications of the terms of these mortgage loans. Delinquent mortgage loans that become performing either because of a payment of past due amounts or a permitted loan modification remain outstanding as part of the aggregated unpaid principal balance of the underlying mortgage loans and therefore will continue to produce revenue for us over their remaining term. The servicer is also able to reimburse itself for outstanding servicing advances when delinquent mortgage loans re-perform. On the other hand, when delinquent mortgage loans are resolved through foreclosure, the unpaid balance of such loans ceases to be a part of the aggregate unpaid principal balance when the related mortgage properties are foreclosed on and liquidated. Also, delinquent mortgage loans resolved through foreclosure generally require more servicing advances over a longer time horizon prior to reimbursement as compared with servicing advances made with respect to delinquent mortgage loans that are resolved through repayment or permitted loan modifications. A faster amortization of the aggregate unpaid principal balance of the underlying mortgage loans and an increase in the amount and duration of outstanding servicing advances would adversely affect our operating results.

Our hedging strategies may not be successful in mitigating the risks associated with changes in interest rates.

We are exposed to interest rate risk to the extent that the interest rates on our financing facilities are tied to a variable rate index and when we refinance those obligations or enter into new facilities. We use and plan to continue to use various derivative and other financial instruments to provide a level of protection against interest rate risks. Although we have executed a hedging strategy aimed to neutralize our net exposure to interest rate increases on our floating rate match funded liabilities and intend to continue to do so, no hedging strategy can completely protect us. Our hedging activities may include entering into interest rate swaps, caps and floors, options to purchase these items and futures and forward contracts. Our hedging decisions are determined in light of the facts and circumstances existing at the time and may differ from our current hedging strategy. Any significant change in interest rates could result in a significant margin call, which would require us to provide the counterparty with additional cash collateral. Any such margin call, or any decline in interest rates that results in the diminution in value of our hedges, could harm our liquidity, profitability, financial condition and business prospects.

If we are named in legal proceedings involving mortgage servicers, the costs of litigation could adversely affect our financial results.

The residential mortgage loan servicing industry is extremely litigious, and we could be subject to allegations of illegality in connection with our own operations or the business practices of subservicers acting on our behalf, including lawsuits related to their billing and collections practices, modification protocols or foreclosure practices and other loss mitigation efforts associated with the mortgage loans they service on our behalf. Ocwen Loan Servicing has informed us that it is currently a defendant in several lawsuits regarding its servicing activities, including putative class actions, and we face the risk that we could be added as a defendant in any of these actions that relate to servicing the Aggregate Purchased Assets.

Ocwen has informed us that it has received a Civil Investigative Demand (“CID”) from the Federal Trade Commission (the “FTC”), requesting documents and information concerning various loan servicing activities. Recently Ocwen was informed that this CID had been referred to the Bureau of Consumer

 

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Financial Protection (“BCFP”), a new federal entity responsible for administering and enforcing the laws and regulations for consumer financial products and services, such as residential mortgage loans. In addition, a coalition of state attorneys general is conducting an industry-wide investigation into certain acts and practices concerning the mortgage foreclosure process. The FTC, the BCFP and such attorneys general have not taken any action against Ocwen, but it is possible that Ocwen could receive notifications of alleged wrongdoing or be named as a defendant with respect to these matters or other litigation and regulatory matters.

We could be added as a defendant or investigated in any of these matters. We also may be added as a defendant in future lawsuits brought against Ocwen, Ocwen Loan Servicing or other servicers regarding their servicing practices relating to our mortgage servicing rights. Defending ourselves against lawsuits or adverse legal judgments against us may require that we pay significant legal fees, settlement costs, damages, penalties or other charges, or undertake remedial actions pursuant to administrative orders or court-issued injunctions, any of which could adversely affect our financial results.

Risks Related to Our Relationship with Ocwen, Other Subservicers and Related Parties

We are dependent on Ocwen Loan Servicing to act as a servicer with respect to the mortgage loans underlying the Acquired Mortgage Servicing Rights.

We are dependent on Ocwen Loan Servicing to service the mortgage loans underlying the Acquired Mortgage Servicing Rights until such time, if at all, as legal ownership of the Acquired Mortgage Servicing Rights are transferred to us. A failure of Ocwen Loan Servicing to perform its servicing obligations under a related pooling and servicing agreement could result in the termination of Ocwen Loan Servicing as servicer. If Ocwen Loan Servicing is terminated, it will no longer receive the servicing fees or any other proceeds with respect to such Acquired Mortgage Servicing Right that it owes to us. If this occurs, we will only have recourse against Ocwen Loan Servicing and will not have any recourse against the related trustee or securitization trust because we will not have legal title to the mortgage servicing rights at that time. If Ocwen Loan Servicing is unable to make any applicable indemnification payments owed to us, we could lose the entire value of the related Rights to MSRs, which would adversely affect our operating results and our ability to pay dividends. We will be exposed to this risk with respect to future purchases of Rights to MSRs from Ocwen Loan Servicing.

We will be dependent on Ocwen Loan Servicing and any other third parties who we engage as subservicer, to perform substantially all of our servicing obligations relating to any mortgage servicing rights we own.

For those mortgage servicing rights that we may ultimately acquire, including the Acquired Mortgage Servicing Rights if and when they are transferred to us and those we may acquire in the Planned Acquisition, we will be contractually obligated to service the loans underlying those mortgage servicing rights. We will not have and in the future do not expect to have the employees, servicing platforms or technical resources necessary to service the loans. We have engaged Ocwen Loan Servicing to service the mortgage loans underlying the Acquired Mortgage Servicing Rights. In addition, we expect to engage Ocwen Loan Servicing or other subservicers to service the mortgage loans underlying any mortgage servicing rights we acquire in the future, including in the Planned Acquisition. If we are unable to engage a subservicer, we will be unable to perform our obligations under the related pooling and servicing agreements, which would lead to our termination as servicer without payment. If for any reason Ocwen Loan Servicing is no longer able to act as subservicer or any other subservicer is no longer able to act as subservicer with respect to any other mortgage servicing rights we may acquire, an alternate subservicer may not be readily available on acceptable terms or at all, which would adversely affect our operating results.

Under the Subservicing Agreement and the applicable subservicing supplements, we will be required to pay Ocwen Loan Servicing fees for servicing the mortgage loans underlying the Acquired Mortgage Servicing Rights. If we fail to pay Ocwen Loan Servicing any monthly base fee or monthly performance

 

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based incentive fee that is past due, subject to certain grace periods and other conditions specified in the Subservicing Agreement and the applicable subservicing supplements, Ocwen Loan Servicing may cease to service the related mortgage loans until such fees have been paid to Ocwen Loan Servicing. Any failure of Ocwen Loan Servicing to service such mortgage loans could result in a servicer termination event or event of default, which could cause us to be terminated as servicer without any right to compensation for the loss of any affected mortgage servicing right.

Failure by Ocwen Loan Servicing and future subservicers to comply with applicable laws and regulations may adversely affect our business.

Mortgage servicing is subject to extensive and evolving federal, state and local laws and regulations. Mortgage servicers are contractually obligated to service the mortgage loans underlying mortgage servicing rights in compliance with such laws and regulations. Failure by Ocwen Loan Servicing or any subservicer we engage in the future to comply with such laws and regulations may result in a servicer termination event or an event of default of the servicer under the related pooling and servicing agreements. If a servicer termination event or event of default has occurred under a pooling and servicing agreement, we may be terminated as servicer (or Ocwen may be terminated as servicer under a pooling and servicing agreement related to an Ocwen Mortgage Servicing Right prior to its transfer to us). As a result, we may not receive any compensation for the loss of the related Mortgage Servicing Assets, other than the right to be reimbursed for any outstanding servicing advances as the related loans are brought current, modified, liquidated or charged off. In addition, the failure of Ocwen Loan Servicing or our other subservicers to comply with these laws and regulations in connection with servicing mortgage loans underlying our mortgage servicing rights, could possibly lead to civil and criminal liability, loss of licensing, damage to our reputation in the industry, fines and penalties and litigation, including class action lawsuits or administrative enforcement actions. Any of these outcomes would have a material adverse effect on our operating results and may make it more difficult for us to acquire additional mortgage servicing rights in the future.

Failure by Ocwen Loan Servicing and future subservicers to ensure that servicing advances comply with the terms of the pooling and servicing agreements may have a material adverse effect on our operating results and our ability to pay dividends in the future.

Although we are responsible for purchasing or funding servicing advances, Ocwen Loan Servicing is responsible for ensuring that servicing advances associated with Ocwen Mortgage Servicing Rights are made in compliance with the terms of the related pooling and servicing agreements and its advance and stop advance policies so that the servicing advances with respect to a mortgage loan do not exceed the amount expected to be collected with respect to such mortgage loan. Future subservicers will have similar responsibilities with respect to future mortgage servicing rights we may acquire. Servicing advances that are improperly made may not be eligible for financing under an advance financing facility and may not be reimbursable by the related securitization trust or other owner of the mortgage loan, which would reduce our liquidity and may cause us to suffer a loss.

If we have to replace Ocwen Loan Servicing, we may not be able to find a suitable replacement, which could adversely affect our financial results.

We intend to continue to capitalize on the servicing capabilities of Ocwen Loan Servicing for the Aggregate Purchased Assets and future acquisitions of Mortgage Servicing Assets. We view Ocwen Loan Servicing as superior relative to many other servicers in terms of cost, management experience, technology infrastructure and platform scalability. If for any reason Ocwen Loan Servicing is no longer able to act as subservicer for us with respect to mortgage servicing rights that we have acquired, or if we decide to require Ocwen Loan Servicing to transfer their mortgage servicing rights to a successor servicer after the occurrence of an event of default under the Purchase Agreement, with respect to the Acquired Mortgage Servicing Rights prior to the transfer of legal ownership to us, or under the Subservicing Agreement, we will need to find a replacement subservicer.

 

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Although there are other entities that may be willing to act as subservicer (or as a successor servicer to Ocwen Loan Servicing with respect to the Ocwen Mortgage Servicing Rights) for us, they may not be of the same quality as Ocwen Loan Servicing, or they may not be willing to act on the same economic terms as Ocwen Loan Servicing. Even if we hire an entity of equal quality and on the same economic terms, there is typically a temporary degradation in the quality of servicing when the servicing of a mortgage loan is transitioned from one subservicer to another. As a result, if we have to replace Ocwen Loan Servicing, our operating results would be adversely affected.

If Ocwen Loan Servicing or any future subservicer fails to adequately perform its loss mitigation obligations, we could be required to make additional servicing advances and the time period for collecting servicing advances may extend.

Ocwen Loan Servicing and any future subservicers that we engage will be required to service the mortgage loans in accordance with specified standards and employ loss mitigation techniques to reduce the probability that borrowers will default on their loans and to minimize losses when defaults occur. These loss mitigation techniques may include the modification of mortgage loan rates and maturities. If Ocwen Loan Servicing or future subservicers fail to adequately perform their loss mitigation obligations under these agreements, we could be required to purchase or fund servicing advances in excess of those that we might otherwise have had to purchase or fund, and the time period for collecting servicing advances may extend. Any increase in servicing advances or material increase in the time to resolution of a defaulted loan could result in increased financing costs to us and adversely affect our liquidity and net income.

Ocwen Loan Servicing may not be able to satisfy its indemnification obligations under the Purchase Agreement and the Subservicing Agreement.

Under the Purchase Agreement, Ocwen Loan Servicing is obligated to indemnify us for losses suffered by us resulting from a breach of Ocwen Loan Servicing’s representations, warranties or covenants relating to any Mortgage Servicing Assets we purchase from it for any of its acts or omissions relating to such Mortgage Servicing Assets occurring prior to the transfer of legal ownership of the related mortgage servicing rights to us.

Under the Subservicing Agreement, Ocwen Loan Servicing is obligated to indemnify us for losses suffered by us resulting from Ocwen Loan Servicing’s failure to observe or perform any of its duties, obligations or covenants, any acts or omissions of Ocwen Loan Servicing or its agents, any breach of its representations and warranties, or any willful malfeasance, bad faith, fraud or negligence in the performance of its duties under the Subservicing Agreement. If we incur a loss for which indemnification may be available against Ocwen Loan Servicing under the Purchase Agreement or the Subservicing Agreement, as the case may be, and if Ocwen Loan Servicing does not have sufficient financial resources available to satisfy its obligation to indemnify us or if it is determined that Ocwen Loan Servicing is not required to provide indemnification, we may experience a loss which could have a material adverse effect on our operations and financial condition.

A downgrade in Ocwen Loan Servicing’s servicer rating and that of any future subservicer with whom we enter into subservicing agreements could have an adverse effect on our business, financial condition or results of operations.

Moody’s, Standard & Poor’s and Fitch rate many mortgage servicers, including Ocwen Loan Servicing. These ratings are subject to change in the future without notice. Servicer ratings are important to our ability to finance servicing advances. For example, the amount of debt that is permitted to be outstanding under the advance financing facility that we have assumed in connection with the Initial Ocwen Purchase will decrease with downgrades in the servicer ratings of Ocwen Loan Servicing. Downgrades in the servicer ratings of any future subservicers we engage could also affect the terms of advance financing facilities that we may enter into in the future, as lenders may require higher interest rates or may limit the amount of money that we can borrow to finance servicing advances if our subservicers’ ratings are deemed by the

 

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lenders to be too low. In addition, some pooling and servicing agreements may also require that the servicer or subservicer maintain specified servicer ratings. The failure to maintain the specified rating may cause the termination of the servicer under such pooling and servicing agreements. Any such downgrade could have an adverse effect on our business, financing activities, financial condition or results of operations. In December 2011, Fitch downgraded Ocwen Loan Servicing’s servicer ratings from RPS2 to RPS3 and RSS2 to RSS3 and maintained “rating watch negative.” On February 21, 2012, Ocwen Loan Servicing received a notice that servicer termination events or events of default had been triggered for certain pooling and servicing agreements underlying the Acquired Mortgage Servicing Rights. This downgrade caused the cumulative percentage of the pooling and servicing agreements with triggered servicer termination events or events of default based on the number of delinquent mortgage loans, loss performance of the related mortgage loans or servicer ratings downgrades to increase. The Servicing Advance Facility Agreements provide that any pooling and servicing agreement that has triggered servicer termination events or events of default due to the downgrade of Ocwen Loan Servicing’s servicer rating by a rating agency do not lose eligibility for advance financing under the existing advance financing facility, unless and until Ocwen Loan Servicing or we receive a notice of termination of servicing.

Our ability to continue borrowing under our liquidity facilities could be adversely affected by events relating to Ocwen, Ocwen Loan Servicing and future subservicers with whom we enter into subservicing agreements.

Under the existing advance financing facility that we have assumed from Ocwen Loan Servicing, our ability to continue borrowing may be limited by the occurrence of certain events relating to Ocwen and Ocwen Loan Servicing. For example, if Ocwen undergoes a change of control or if Ocwen Loan Servicing fails to satisfy certain liquidity tests, this would constitute an early amortization event and the lenders under that facility may cease funding our servicing advances. If Ocwen defaults under a full-recourse term loan, including Ocwen’s senior secured term loan, that would constitute an event of default under our existing advance financing facility. If one of these events occurs and our lenders cease funding our servicing advances, we may not be able to arrange for a replacement facility to finance the servicing advances that we are obligated to continue purchasing from Ocwen Loan Servicing. Our inability to obtain adequate financing to fund servicing advances would result in the termination of our mortgage servicing rights under the applicable pooling and servicing agreement or our Rights to MSRs pursuant to the Purchase Agreement, as applicable. See “Description of Servicing Advance Facility Agreements and Advance Financing Facility.”

If we are required to register under the Investment Company Act, our ability to conduct our business could be materially adversely affected, and you could suffer losses.

We are not registered, and do not intend to register, as an investment company under the Investment Company Act of 1940 (the “Investment Company Act”). Under Section 3(a)(1)(A) of the Investment Company Act, a company is not deemed to be an “investment company” if it neither is, nor holds itself out as being, engaged primarily, nor proposes to engage primarily, in the business of investing, reinvesting or trading in securities. Under Section 3(a)(1)(C) of the Investment Company Act, a company is not deemed to be an “investment company” if it (1) neither is engaged, nor proposes to engage, in the business of investing, reinvesting, owning, holding or trading in securities and (2) does not own or propose to acquire “investment securities” having a value exceeding 40% of the value of its total assets (exclusive of government securities and cash items) on an unconsolidated basis (the “40% test”). “Investment securities” excludes (A) government securities, (B) securities issued by employees’ securities companies and (C) securities issued by majority-owned subsidiaries which are not investment companies, and which are not relying on the exception from the definition of investment company under Section 3(c)(1) or 3(c)(7) of the Investment Company Act.

We intend to conduct our operations directly and through wholly or majority-owned operating subsidiaries, so that we and each of our subsidiaries is not an investment company under the Investment Company Act. We believe that neither we nor our operating subsidiaries will be considered an investment

 

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company under Section 3(a)(1)(A) of the Investment Company Act because neither we nor our operating subsidiaries will engage primarily, or hold ourselves or our operating subsidiaries out as being engaged primarily, in the business of investing, reinvesting or trading in securities. Rather, we, through our operating subsidiaries, will be primarily engaged in the non-investment company business of these subsidiaries, namely the business of purchasing or otherwise acquiring mortgage servicing rights, Rights to MSRs, and associated servicing advances and engaging and managing one or more high-quality residential mortgage loan servicers to service the pools of mortgage loans underlying the mortgage servicing rights. We intend to structure the special purpose entities that we establish in connection with match funded advance financing facilities to rely on the investment company exemption provided to certain structured financing vehicles by Rule 3a-7 promulgated pursuant to the Investment Company Act.

We monitor our business strategy and assets to ensure continuing and ongoing compliance with the Investment Company Act. A change in our business strategy or in the value or classification of any of our assets could cause us or one or more of our wholly owned or majority owned operating subsidiaries to fall within the definition of “investment company” and negatively affect our ability to maintain our exemption from regulation under the Investment Company Act. For example, if we are unable to obtain legal ownership of mortgage servicing rights either due to the unwillingness of necessary consent parties or demands that do not fit within our business strategy (such as building or purchasing a servicing platform), we may be required to make changes to our business strategy and operations to avoid us or any of our operating subsidiaries being required to register as an investment company under the Investment Company Act. Changes to our business plan and operations could include amendment or modification of the Purchase Agreement or Subservicing Agreement, providing for increased control by us over Ocwen Loan Servicing’s servicing activities with respect to mortgage loans underlying our Rights to MSRs, or acquiring mortgage servicing rights which do not require the confirmation of a rating agency or consent of another party that has indicated that it would not provide a ratings confirmation or consent to the transfer of the mortgage servicing rights to us, such as private-label mortgage servicing rights that are not rated by particular rating agencies or mortgage servicing rights that are related to loans that are guaranteed or securitized by the U.S. government or government sponsored entities such as Fannie Mae and Freddie Mac (collectively, the “GSEs”). We may also be unable to sell assets we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income- or loss-generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire Rights to MSRs that we would otherwise want to acquire and would be important to our business strategy.

If, however, we or any of our subsidiaries are deemed to be an investment company under the Investment Company Act, we may be required to institute burdensome compliance requirements and our activities may be restricted, among other things, which would materially adversely affect our business, financial condition and results of operations and our ability to pay dividends. For example, because affiliate transactions are generally prohibited under the Investment Company Act, we would not be able to enter into transactions with any of our affiliates if we are required to register as an investment company, and we may be required to terminate the Purchase Agreement, the Subservicing Agreement, the Ocwen Professional Servicing Agreement, the Altisource Administrative Services Agreement and any other agreements with affiliates and forgo opportunities to purchase additional Rights to MSRs from Ocwen Loan Servicing as currently contemplated. If we or one of our subsidiaries were deemed to be an investment company, we may also seek exemptive relief from the Securities and Exchange Commission (“SEC”), which could impose significant costs on our business. If we or any of our subsidiaries were required to register as an investment company but failed to do so, the unregistered entity would be prohibited from engaging in business, and criminal and civil actions could be brought against such unregistered entity. In addition, the contracts of such unregistered entity would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of such unregistered entity and liquidate the unregistered entity, which could lead to losses to our shareholders.

 

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We may require the cooperation of Ocwen Loan Servicing to maintain our exemption from registration as an investment company under the Investment Company Act.

We may be required to make changes to our business strategy and operations to avoid the registration of us or any of our operating subsidiaries as an investment company under the Investment Company Act. Such changes could include amendment or modification of the Purchase Agreement or Subservicing Agreement or changes to the structure of future arrangements with Ocwen Loan Servicing. For example, we may be required to change the structure of future acquisitions of Mortgage Servicing Assets or the degree of control exercised by us over Ocwen Loan Servicing’s servicing activities with respect to mortgage loans underlying our Rights to MSRs. Although Ocwen Loan Servicing is contractually obligated in the Purchase Agreement to use all commercially reasonable efforts to make any changes necessary to our relationship and agreements so that we and our operating subsidiaries will not be required to register as an investment company, the necessary changes may not be acceptable to us, or Ocwen Loan Servicing may disagree that it is required to make the particular changes under the terms of the Purchase Agreement. In addition, the changes that we implement to our business strategy or operations may not be sufficient to avoid registration as an investment company or may have a negative effect on our results of operations and financial condition. If we are required to register under the Investment Company Act, our ability to conduct our business could be materially adversely affected, and you could suffer losses.

We could have conflicts of interest with Ocwen, and our officers and directors also could have conflicts of interest due to their relationships with us and Ocwen, that could be resolved in a manner adverse to us.

We have entered into various agreements with subsidiaries of Ocwen and we intend to enter into further agreements with Ocwen or its subsidiaries in the future. Certain of our executive officers and directors may have conflicts of interest with respect to such agreements and other matters due to their past and/or current relationships with Ocwen.

William C. Erbey, the Chairman of our Board of Directors, is, and for the foreseeable future is expected to be, the Chairman of the Board of Directors of Ocwen. As a result, he has obligations to us as well as to Ocwen and may have conflicts of interest with respect to matters potentially or actually involving or affecting us and Ocwen. Mr. Erbey is the beneficial owner of approximately 13.2% of Ocwen’s common stock as of September 30, 2012. Richard Delgado, who is our Treasurer, owned 24,582 shares of Ocwen common stock as of September 30, 2012. In addition, in connection with their resignation from their positions at Ocwen at the time of the closing of our initial public offering, the Ocwen Board of Directors extended the post-termination exercise period of options to purchase 625,000 shares of Ocwen common stock held by Mr. Van Vlack, of which 460,000 shares are unexercised, 30,098 shares of Ocwen common stock held by Mr. Delgado and 20,000 shares of Ocwen common stock held by Michael J. McElroy, who is our General Counsel, so that the options may be exercised during the original term of the option, subject to any existing vesting schedules of those options. The options would otherwise have expired following the date of such officers’ resignation from Ocwen. This ownership of Ocwen common stock and options to purchase Ocwen common stock could create or appear to create potential conflicts of interest when our Board of Directors or our executive officers are faced with decisions that involve Ocwen.

Matters that could give rise to conflicts between us and Ocwen include, among other things:

 

   

our ongoing and future relationships with Ocwen, including agreements, amendments to agreements and other arrangements with respect to servicing the mortgage loans underlying our Mortgage Servicing Assets and potential future acquisitions of Mortgage Servicing Assets from Ocwen;

 

   

the quality and pricing of services that Ocwen has agreed to provide to us;

 

   

the quality, valuation and pricing of Mortgage Servicing Assets that Ocwen has agreed to sell to us or may sell to us in the future; and

 

   

any competitive actions by Ocwen.

 

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We will seek to manage these potential conflicts through oversight by the independent members of our Board of Directors. Such measures may not be effective, and we may not be able to resolve all conflicts with Ocwen. In addition, the resolution of any such conflicts may be less favorable to us than if we were dealing with an unaffiliated third party.

We could have conflicts with Altisource that could be resolved in a manner adverse to us.

We have entered into an administrative services agreement with Altisource, which we refer to as the “Altisource Administrative Services Agreement” throughout this prospectus. We also lease office space in the United States from Altisource. Certain of our executive officers and directors may be subject to conflicts of interest with respect to such agreements and other matters due to their past and/or current relationships with Altisource.

William C. Erbey, the Chairman of our Board of Directors, is the Chairman of the Board of Directors of Altisource. As a result, he has obligations to us as well as to Altisource and may have conflicts of interest with respect to matters potentially or actually involving or affecting us and Altisource. Mr. Erbey is the beneficial owner of approximately 23% of Altisource’s common stock as of September 30, 2012. This ownership could create or appear to create potential conflicts of interest when our Board of Directors is faced with decisions that involve Altisource.

We manage these potential conflicts through oversight by the independent members of our Board of Directors. Such measures may not be effective, and we may not be able to resolve all conflicts with Altisource. In addition, the resolution of any such conflicts may be less favorable to us than if we were dealing with an unaffiliated third party.

The Purchase Agreement, Subservicing Agreement, Ocwen Professional Services Agreement and Altisource Administrative Services Agreement were not negotiated on an arm’s-length basis and the terms may not be as favorable to us as if such agreements were negotiated with unaffiliated third parties.

Because William C. Erbey, our founder and Chairman of our Board of Directors, is also the Chairman of the Board of Directors and largest shareholder of Ocwen and the Chairman of the Board of Directors and largest shareholder of Altisource, the terms of our agreements with them have not been negotiated on an arm’s-length basis, and any agreements we enter into with them in the future will likely not be negotiated on an arm’s-length basis. As a result, certain terms of these agreements may not be as favorable to us as agreements negotiated with unaffiliated third parties. Furthermore, we may choose not to enforce, or to enforce less vigorously, our rights under such agreements because of our desire to maintain our ongoing relationships with Ocwen and Altisource.

We rely on an exception to the rules of The NASDAQ Stock Market which require that all members of the Nominating and Corporate Governance Committee of our Board of Directors be independent, and, as a result, our shareholders will not have the protections afforded by this corporate governance requirement.

The rules of The NASDAQ Stock Market provide that, under limited and exceptional circumstances, a director who is not a current officer or employee (or a family member of an officer or employee) of our company, but who does not otherwise meet the independence criteria established by The NASDAQ Stock Market, may serve as a member of the Nominating and Corporate Governance Committee if such membership is in the best interests of our company and our shareholders. Our Board of Directors has elected to rely on this limited exception in appointing Mr. Erbey as the Chairman of the Nominating and Corporate Governance Committee. As a result, our shareholders will not have the same protections afforded to shareholders of companies that do not rely on this exception.

 

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Ocwen Loan Servicing’s failure to perform adequately in external audits could have an adverse effect on our business, financial condition or results of operations.

We do not intend to build a mortgage servicing platform and will depend on Ocwen Loan Servicing to maintain the controls and processes needed to perform adequately on external audits, including in connection with reporting obligations under the pooling and servicing agreements and SEC reporting obligations, and other agreed-upon procedures for the advance financing facility that we assumed in connection with the Initial Ocwen Purchase and will depend on Ocwen Loan Servicing and possibly other subservicers to perform these functions for mortgage servicing rights we acquire in the future. The failure to pass such audits and to remediate issues identified could lead to a downgrade in Ocwen Loan Servicing’s servicer rating, which could have the consequences described above under “—A downgrade in Ocwen Loan Servicing’s servicer rating and that of any future subservicer with whom we enter into subservicing agreements could have an adverse effect on our business, financial condition or results of operations” or could lead to interruptions in, or the loss of, our advance financing.

A failure in Ocwen Loan Servicing or any of our future subservicers’ operational systems or information technology and security infrastructure, or those of third parties, could disrupt our business, result in the disclosure of confidential information, damage our reputation and cause losses.

Our business is substantially dependent on Ocwen Loan Servicing’s and any future subservicers’ ability to process and monitor a large number of transactions, many of which are complex, across numerous and diverse real estate markets. These transactions often must adhere to the terms of the underlying pooling and servicing agreements, as well as legal and regulatory standards governing the use and disclosure of sensitive consumer information. Ocwen Loan Servicing and any future subservicers are responsible for developing and maintaining operational systems and information technology and security infrastructure, which is challenging and depends, in part, on the ability of our subservicers, including Ocwen Loan Servicing, to monitor third-party service providers to whom our subservicers outsource information technology and data processing functions. Ocwen Loan Servicing and any future subservicers’ financial, accounting, data processing, security or other operating systems and facilities may fail to operate properly or become disabled as a result of events that are wholly or partially beyond their control, such as a spike in transaction volume, cyber attacks or unforeseen catastrophic events, adversely affecting their ability to process these transactions.

In addition, Ocwen Loan Servicing’s and any future subservicers’ operations rely on the secure processing, storage and transmission of confidential and other information in their computer systems and networks and those of outsourced third-party service providers. Although Ocwen Loan Servicing’s and any future subservicers are expected to take protective measures and endeavor to modify them as circumstances warrant, their computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code, and other events that could have a security impact. Given the volume of transactions Ocwen Loan Servicing and any future subservicers will process and monitor, certain errors may be repeated or compounded before they are discovered and rectified. If one or more of such events occurs, this could potentially jeopardize confidential and other information processed and stored in, and transmitted through, the computer systems and networks of Ocwen Loan Servicing and any future subservicers, which could result in significant compliance and remediation losses, reputational damage and legal liabilities to us.

Risks Related to Government Regulation

The expanding body of federal, state and local regulation and/or the licensing of mortgage servicers or other aspects of our business may increase our costs.

The servicing of residential mortgage loans is subject to extensive federal, state and local laws, regulations and administrative decisions. The volume of new or modified laws and regulations has increased in recent years and is likely to continue to increase. For example, on August 10, 2012, the BCFP proposed new regulations that would require mortgage servicers in part to provide enhanced statements to

 

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borrowers, provide notice of interest rate changes, correct errors and obtain information for borrowers, apply payments promptly, apply “force-placed” insurance only when they reasonably believed borrower’s policies had lapsed, provide greater access to servicer personnel and records, engage in outreach to delinquent borrowers with foreclosure alternatives, and allow borrowers to appeal denials of loan modifications and delay foreclosure proceedings while those applications or appeals are pending. If implemented, these rules or other new laws and regulations affecting the mortgage servicing industry could increase the cost of servicing loans. This may force us to have to pay increased fees to Ocwen Loan Servicing or other servicers when we renew our agreements with them at the end of their terms or enter into new subservicing agreements. In addition, our ability to purchase Mortgage Servicing Assets may be limited if we cannot engage mortgage servicers at fee rates that allow us to achieve the objectives of our business model. We will also become subject to licensing in some states if and when we become an owner of mortgage servicing rights. If the number of states that require the licensing of owners of mortgage servicing rights increases, or the states that require licensing impose additional obligations on the owners of mortgage servicing rights, our costs could increase. Any of these outcomes may adversely affect our results of operations or financial condition.

Regulatory scrutiny regarding foreclosure processes could lengthen foreclosure timelines or increase prepayment speeds which would negatively impact our liquidity and profitability.

Various state banking regulators and attorneys general have publicly announced that they have initiated inquiries into banks and servicers regarding compliance with legal procedures in connection with mortgage foreclosures, including the preparation, execution, notarization and submission of documents, principally affidavits, filed in connection with foreclosures. The process to foreclose on properties securing residential mortgage loans is governed by state law and varies by state. For the most part, these inquiries have arisen from the 23 so-called “judicial states”; namely, those jurisdictions that require lenders or their servicers to go through a judicial proceeding to obtain a foreclosure order. In these judicial states, lenders or their servicers are generally required to provide to the court the mortgage loan documents and a sworn and notarized affidavit of an officer of the lender or its servicer with respect to the facts regarding the delinquency of the mortgage loan and the foreclosure. These affidavits are generally required to be based on the personal knowledge of the officer that executes the affidavit after a review of the mortgage loan documents. Regulators from “quasi-judicial states” and “non-judicial states,” however, have made similar inquiries as well. In these states, lenders or their servicers may foreclose on a defaulted mortgage loan by delivering to the borrower a notice of the foreclosure sale without the requirement of going through a judicial proceeding, unless the borrower contests the foreclosure or files for bankruptcy. If the borrower contests the foreclosure or files for bankruptcy in a non-judicial state, court proceedings, including affidavits similar to those provided in the judicial states, will generally be required.

In connection with the recent governmental scrutiny of foreclosure processes and practices in the industry, the attorneys general of certain states and certain members of the U.S. Congress and state legislatures have called for a temporary moratorium on mortgage foreclosures, although no state has implemented a general foreclosure moratorium on mortgage loan servicers to date. In addition, some individual municipalities have begun to enact laws that may increase the time that it currently takes to complete a foreclosure or prevent foreclosures in such jurisdictions. Such moratoria or other action by federal, state or municipal government bodies, regulators or courts could increase the length of time needed to complete the foreclosure process. For example, the average number of days for Ocwen Loan Servicing to complete a foreclosure action during 2011 increased by 133 days in judicial foreclosure states and 32 days in traditional non-judicial foreclosure states as compared to 2010 averages. In the first six months of 2012, foreclosure timelines increased by an additional 102 days in judicial foreclosure states and 34 days in traditional non-judicial foreclosure states as compared to 2011 averages.

When a mortgage loan is in foreclosure, we are generally required to continue to advance delinquent principal and interest to the securitization trust and to also make advances for delinquent taxes and insurance and foreclosure costs and the upkeep of vacant property in foreclosure to the extent we determine that such amounts are recoverable. These servicing advances are generally recovered when the

 

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delinquency is resolved. Foreclosure moratoria or other actions that lengthen the foreclosure process will increase the amount of servicing advances we are required to make, lengthen the time it takes for us to be reimbursed for such advances and increase the costs incurred during the foreclosure process. In addition, advance financing facilities generally contain provisions that limit the eligibility of servicing advances to be financed based on the length of time that servicing advances are outstanding, and, as a result, an increase in foreclosure timelines could further increase the amount of servicing advances that we need to fund with our own capital. Such increases in foreclosure timelines could increase our need for capital to fund servicing advances which would increase our interest expense, delay the collection of interest income or servicing fee revenue until the foreclosure has been resolved and, therefore, reduce the cash that we have available to pay our operating expenses or to pay dividends.

Governmental bodies may also impose regulatory fines or penalties as a result of our subservicers’ foreclosure processes or impose additional requirements or restrictions on such activities which could increase their operating expenses. For instance, in April 2011 the Office of the Comptroller of the Currency (“OCC”), the Board of Governors of the Federal Reserve System (“FRB”) and the Federal Deposit Insurance Corporation (“FDIC”) entered into consent orders with the fourteen largest mortgage servicers to address alleged deficient practices in residential mortgage loan servicing and foreclosure processing. Under the consent orders, these mortgage servicers are required to submit written remediation plans addressing enterprise-wide risk management, internal audit and compliance programs for their residential mortgage loan servicing, loss mitigation and foreclosure activities. Remedial measures required under these consent orders and written plans may include, among other measures, revisions to servicing operations and remediation of all financial injury to borrowers caused by any errors, misrepresentations or other deficiencies identified in the parties’ recent foreclosures. Ocwen Loan Servicing is not subject to OCC, FRB or FDIC regulation, and therefore it has not been subject to any consent decree initiated by these federal regulatory agencies. Nonetheless, Congress or federal or state regulatory agencies could subject it and other independent servicers to similar consent decrees, enforcement actions or investigations. In general, these regulatory developments with respect to foreclosure practices could result in increases in the amount of servicing advances and the length of time to recover servicing advances, fines or increases in operating expenses, and decreases in the advance rate and availability of financing for servicing advances. This would lead to increased borrowings, reduced cash and higher interest expense which could negatively impact our liquidity and profitability, and although the Subservicing Agreement and the Purchase Agreement relating to the Purchased Assets and the subservicing supplement relating to the Aggregate Purchased Assets contain adjustment mechanisms that would reduce the amount of incentive fees payable to Ocwen Loan Servicing if servicing advances exceed pre-determined amounts, those fee reductions may not be sufficient to cover the expenses resulting from longer foreclosure timelines.

On February 9, 2012, the Department of Housing and Urban Development and attorneys general representing 49 states and the District of Columbia announced a $25 billion settlement (the “Joint Federal-State Servicing Settlement”) with the five largest mortgage servicers—Bank of America Corporation, JP Morgan Chase & Co., Wells Fargo & Company, Citigroup Inc. and Ally Financial Inc. (formerly GMAC)—regarding servicing and foreclosure issues. In addition to assessing monetary penalties which are required to be used to provide financial relief to borrowers (including refinancing and principal write-downs), the Joint Federal-State Servicing Settlement requires these servicers to implement changes in how they service mortgage loans, handle foreclosures and provide information to bankruptcy courts. The federal-state regulators may seek to expand the participation in the Joint Federal-State Servicing Settlement or similar settlements to other servicers and could seek to include Ocwen Loan Servicing. Implementation of the servicing practices associated with the Joint Federal-State Servicing Settlement could result in increased costs for servicing mortgage loans generally, which could lead to higher subservicing fees being charged to us for subsequent mortgage servicing assets we acquire. In addition, the implementation of a refinancing or principal write-down program like that contemplated by the Joint Federal-State Servicing Settlement could result in an increase in prepayment speeds and negatively affect our earnings and operating results.

 

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GSE initiatives and other actions may affect mortgage servicing generally and future servicing fees in particular.

On January 17, 2011, the Federal Housing Finance Agency announced that it has instructed Fannie Mae and Freddie Mac to study possible alternatives to the current residential mortgage servicing and compensation system used for single-family mortgage loans. A discussion paper containing alternative mortgage servicing compensation proposals was released at the direction of the Federal Housing Finance Agency on September 27, 2011. It requested comment on a number of proposals, including a proposal implementing a “fee for services” model of servicer compensation, in which Fannie Mae or Freddie Mac would pay the servicer a fee for servicing mortgage loans based on the delinquency status of each mortgage loan. Although the mortgage loans underlying the Acquired Mortgage Servicing Rights or other pooling and servicing agreements that have already been executed are not subject to any changes implemented by Fannie Mae or Freddie Mac, because of the significant role of Fannie Mae and Freddie Mac in the secondary mortgage market, it is possible that any changes they implement could become prevalent in the mortgage servicing industry generally going forward. Other industry stakeholders or regulators may also implement or require changes in response to the perception that the current mortgage servicing practices and compensation do not serve broader housing policy objectives well. These proposals are still evolving. To the extent the GSEs implement reforms that materially affect the market for conforming loans, there may be secondary effects on the subprime and Alt-A markets, which may have a material adverse effect on the creation of new mortgage servicing rights or the economics or performance of any mortgage servicing rights or Rights to MSRs that we acquire.

Risks Related to Taxation

We expect to be treated as a PFIC for U.S. federal income tax purposes, which could subject U.S. Holders to adverse U.S. federal income tax consequences.

We expect to be treated as a PFIC for U.S. federal income tax purposes. A PFIC generally is a foreign corporation if either at least (i) 75% of its gross income is “passive income,” or (ii) 50% of the gross value of its assets is attributable to assets that produce, or are held for the production of, passive income. If you are a U.S. Holder and do not make a QEF election with respect to us or a mark-to-market election with respect to our ordinary shares, you will be subject to adverse tax consequences, including deferred tax and interest charges with respect to certain distributions on our ordinary shares, any gain realized on a disposition of our ordinary shares and certain other events. The effect of these adverse tax consequences could be materially adverse to you. If you are a U.S. Holder and make a valid, timely QEF election for us, you will not be subject to those adverse tax consequences, but could recognize taxable income in a taxable year with respect to our ordinary shares in excess of any distributions that we make to you in that year, thus giving rise to so-called “phantom income” and to a potential out-of-pocket tax liability. We will provide information to all electing shareholders needed to comply with the QEF election. If you are a U.S. Holder and make a valid, timely mark-to-market election with respect to our ordinary shares, you will recognize as ordinary income or loss in each year that we are a PFIC an amount equal to the difference between your basis in our ordinary shares and the fair market value of the ordinary shares, thus also possibly giving rise to phantom income and a potential out-of-pocket tax liability. Ordinary loss generally is recognized only to the extent of net mark-to-market gains previously included in income. U.S. Holders should be aware that although we currently do not have any subsidiaries that are PFICs, we may form or acquire a subsidiary that is a PFIC in the future. In such event, U.S. Holders will also need to make the QEF election with respect to each such subsidiary in order to avoid the adverse tax consequences described above. We intend to provide all information necessary for U.S. Holders to make the QEF election with respect to any of our subsidiaries that may be classified as a PFIC. U.S. Holders should also be aware that the mark-to-market election generally will not be available with respect to any our subsidiaries that is a PFIC, rendering such election less beneficial to U.S. Holders than the QEF election. See “Material Cayman Islands and United States Federal Income Tax Considerations—United States Federal Income Taxation—Consequences to U.S. Holders—Passive Foreign Investment Company Status and Related Tax Consequences.”

 

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If the IRS determines that we are not a PFIC, and you previously paid taxes pursuant to a QEF election or a mark-to-market election, you may pay more taxes than you legally owe.

While we expect to be treated as a PFIC for U.S. federal income tax purposes, our tax counsel has indicated that there is a risk that we will not be treated as such. If the U.S. Internal Revenue Service (“IRS”) makes a determination that we are not a PFIC in the future, then you may have paid more taxes than you legally owed due to a QEF or mark-to-market election. If you do not, or are not able to, file a refund claim before the expiration of the applicable statute of limitations, you will not be able to claim a refund for those taxes.

Distributions that we pay to individual U.S. Holders will not be eligible for taxation at reduced rates.

Distributions made to a U.S. Holder that is an individual will not be eligible for taxation at reduced tax rates generally applicable (for tax years beginning before January 1, 2013) to dividends paid by certain U.S. corporations and “qualified foreign corporations.” The more favorable rates applicable to regular corporate dividends could cause individuals to perceive investment in our ordinary shares to be relatively less attractive than investment in the shares of other corporations, which could adversely affect the value of our ordinary shares.

If we are treated as engaged in a trade or business in the United States, we would become subject to U.S. federal income taxation, which could adversely affect our business and result in decreased cash available for distribution to our shareholders.

The IRS could assert that we are engaged in a U.S. trade or business because we own mortgage servicing rights and are participating in the servicing of U.S. mortgage loans, either directly or through agents such as Ocwen Loan Servicing. If, contrary to our expectations, we are treated as engaged in a trade or business in the United States, we would be subject to U.S. federal income taxation on a net income basis, which would adversely affect our business and result in decreased cash available for distribution to our shareholders. More specifically, if we are treated as engaged in a trade or business in the United States, the portion of our net income, if any, that was “effectively connected” with such trade or business would be subject to U.S. federal income taxation at a maximum rate of 35%, as opposed to our expectation that only income of our subsidiary that is taxed as a corporation for U.S. federal income tax purposes will be subject to U.S. federal income tax at such rate. In addition, we would be subject to the U.S. federal branch profits tax on our effectively connected earnings and profits at a rate of 30%.

We may become subject to taxation in the Cayman Islands.

The Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. Dividend payments are not subject to withholding tax in the Cayman Islands. There are no other taxes likely to be material to our company levied by the government of the Cayman Islands, except for stamp duties that may be applicable on instruments executed in, or after execution brought within the jurisdiction of, the Cayman Islands. The tax treatment of our business in the Cayman Islands is subject to change. Thus, we may become subject to Cayman Islands taxation in the future.

Risks Related to Our Ordinary Shares and this Offering

An active trading market for our ordinary shares may not be sustained.

Our shares are listed on The NASDAQ Global Select Market under the symbol “HLSS.” However, an active trading market for our ordinary shares may not be sustained. Accordingly, your ability to sell ordinary shares when desired, or the prices that may be obtained for such shares, will depend on the existence and liquidity of an active trading market for our ordinary shares.

 

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The market price and trading volume of our ordinary shares may be volatile, which could result in losses for our shareholders.

The market price of our ordinary shares may be highly volatile and could be subject to wide fluctuations. In addition, the trading volume of our ordinary shares may fluctuate and cause significant price variations to occur. If the market price of our ordinary shares declines significantly, you may be unable to resell your shares at or above your purchase price, if at all. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our ordinary shares include:

 

   

changes in our dividend policy;

 

   

continued deterioration of the housing market or general market or economic conditions;

 

   

increases in market interest rates;

 

   

variations in our quarterly or annual operating results;

 

   

changes in our earnings estimates or differences between our actual financial and operating results and those expected by investors and analysts;

 

   

the contents of published research reports about us, Ocwen, other mortgage loan servicers or the mortgage servicing industry or the failure of securities analysts to cover our ordinary shares;

 

   

changes to our business strategy or the way we conduct our operations, including our inability to obtain any third party approvals or consents required to transfer legal ownership of mortgage servicing rights to us;

 

   

our inability to fund the purchase of additional mortgage servicing rights;

 

   

additions or departures of key management personnel;

 

   

any indebtedness we may incur in the future;

 

   

actions by institutional shareholders;

 

   

litigation and governmental investigations;

 

   

tax changes that may subject our net income to corporate level taxation;

 

   

announcements by us, Ocwen or others and developments affecting us or Ocwen or speculation or reports by the press or investment community with respect to us, Ocwen or the mortgage servicing industry in general;

 

   

changes or proposed changes in laws or regulations affecting the mortgage servicing industry or enforcement of these laws and regulations, or announcements relating to these matters; and

 

   

realization of any of the risks described elsewhere under “Risk Factors.”

In addition, equity markets have experienced significant price and volume fluctuations that have affected the market prices for the securities of newly public companies for a number of reasons, including reasons that may be unrelated to our business or operating performance. These broad market fluctuations may result in a material decline in the market price of our ordinary shares, and you may not be able to sell your ordinary shares at prices you deem acceptable. In the past, following periods of volatility in the equity markets, securities class action lawsuits have been instituted against public companies. Such litigation, if instituted against us, could result in substantial cost and the diversion of management attention.

 

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Sales of ordinary shares by us in the future could adversely affect the market price of our ordinary shares.

We expect that we will sell additional ordinary shares from time to time in the future primarily in connection with the acquisition of additional Rights to MSRs or mortgage servicing rights. Sales of additional ordinary shares by us for whatever reason may adversely affect the trading price of our ordinary shares and will dilute the percentage ownership of us by our then-existing shareholders, including shareholders that purchase in this offering.

Future sales of ordinary shares by our principal shareholder could cause our ordinary share price to decline.

In connection with our initial public offering, William C. Erbey entered into a written “lock-up” agreement providing, among other things, that he will not sell the ordinary shares he purchased in the private placement for a period of 18 months following the date of the pricing of our initial public offering without the prior written consent of Wells Fargo Securities, LLC. However, the lock-up agreement is subject to a number of specified exceptions. See “Underwriting.” Pursuant to a Registration Rights Agreement that we have entered into with Mr. Erbey, we have granted to Mr. Erbey demand registration rights, which he may exercise one time, and unlimited piggyback registration rights, which, subject to the applicable lock-up restrictions, may require us to register his ordinary shares beginning 18 months from the date of the pricing of our initial public offering. Upon expiration of the lock-up agreement, Mr. Erbey will be able to freely sell these ordinary shares, subject to volume limitations pursuant to Rule 144 under the Securities Act for so long as Mr. Erbey is an affiliate of ours.

If equity research analysts issue unfavorable commentary or downgrade our ordinary shares, the price of our ordinary shares could decline.

The trading price of our ordinary shares is affected by research and reports that equity research analysts publish about us, Ocwen or the mortgage servicing industry. We do not control these analysts. The price of our ordinary shares could decline if one or more equity analysts downgrade our ordinary shares or if analysts issue other unfavorable commentary or cease publishing reports about us, Ocwen or the mortgage servicing industry.

As a public company we incur significant costs and face demands on our management to comply with the SEC and stock exchange requirements.

As a public company with shares listed on a U.S. securities exchange, we need to comply with an extensive body of regulations, including provisions of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), regulations of the SEC and requirements of The NASDAQ Stock Market. These rules and regulations could result in substantial legal and financial compliance costs and make some activities more time-consuming and costly. In addition, we incur costs associated with our public company reporting requirements and maintaining directors’ and officers’ liability insurance. Furthermore, our management has increased demands on its time in order to ensure we comply with public company reporting requirements and the compliance requirements of the Sarbanes-Oxley Act, as well as any rules subsequently implemented by the SEC and the applicable stock exchange requirements of The NASDAQ Stock Market.

We are required by Section 404 of the Sarbanes-Oxley Act to evaluate the effectiveness of our internal controls by the end of fiscal 2013, and we may identify control deficiencies, which may be expensive to remediate, and could affect the ability of our auditor to issue an unqualified audit report, which could affect our share price.

As a U.S.-listed public company, we are required to comply with Section 404 of the Sarbanes-Oxley Act by December 31, 2013. Section 404 requires that a public company evaluate its internal control over financial reporting to enable management to report on, and the company’s independent auditors to audit as

 

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of the end of the next fiscal year, the effectiveness of those controls. During the course of our review, we may identify control deficiencies of varying degrees of severity, and we may incur significant costs to remediate those deficiencies or otherwise improve our internal controls. As a public company, we are required to report control deficiencies that constitute a “material weakness” in our internal control over financial reporting. Public companies are also required to obtain an audit report from their independent auditors regarding the effectiveness of their internal controls over financial reporting. If we fail to implement the requirements of Section 404 in a timely manner, we may be subject to sanctions or investigation by regulatory authorities, including the SEC or FINRA. Furthermore, if we discover a material weakness or our auditor does not provide an unqualified audit report when required, our share price could decline, our reputation could be significantly harmed and our ability to raise capital could be impaired. Management is not currently aware of any factors that could result in the determination that there is a material weakness in our internal controls. Although we qualify as an “Emerging Growth Company” as defined in the JOBS Act, we do not intend to rely on the relief provided to EGC’s from the requirement that our independent auditors audit the effectiveness of our internal control over financial reporting as of the end of the next fiscal year. We are, however, under no obligation to do so for as long as we are an EGC.

We are a Cayman Islands exempted company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than under U.S. law, you may have less protection of your shareholder rights than you would under U.S. law.

Our corporate affairs are governed by Cayman Islands law and our Articles of Association. The rights of shareholders to take action against our directors, the rights of minority shareholders to institute actions and the fiduciary responsibilities of our directors to us are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, the latter of which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in the United States. In particular, the Cayman Islands has a less developed body of securities law than the United States. In addition, a Cayman Islands company may not have standing to initiate a shareholder derivative action before the federal courts of the United States. As a result, our shareholders may encounter more difficulty in protecting their interests against actions taken by our management or Board of Directors than they would as shareholders of a public company incorporated in the United States. See “Description of Share Capital—Differences in Corporate Law.”

You may have difficulty enforcing judgments obtained against us.

We are a Cayman Islands exempted company, and it may be difficult for you to enforce judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors. In addition, the courts of the Cayman Islands may not recognize or enforce judgments of U.S. courts against us or our directors and officers predicated upon the civil liability provisions of the securities laws of the United States or any state. Furthermore, Cayman Islands courts may not be competent to hear original actions brought in the Cayman Islands against us or our directors and officers predicated upon the securities laws of the United States or any state. See “Enforceability of Civil Liabilities.”

 

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FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements, other than statements of historical facts, included in this prospectus, including, without limitation, statements regarding the assumptions we make about our business and economic model, our dividend policy, business strategy and other plans and objectives for our future operations, are forward-looking statements.

These statements include declarations regarding our management’s beliefs and current expectations. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “would,” “could,” “expects,” “plans,” “contemplate,” “anticipates,” “believes,” “estimates,” “predicts,” “projects,” “intend” or “continue” or the negative of such terms or other comparable terminology, although not all forward-looking statements contain these identifying words. These forward-looking statements are subject to inherent risks and uncertainties in predicting future results and conditions that could cause the actual results to differ materially from those projected in these forward-looking statements. Some, but not all, of the forward-looking statements contained in this prospectus include, among other things, statements about the following:

 

   

estimates regarding prepayment speeds, delinquency rates, servicing advances, amortization of mortgage servicing assets, custodial account balances, interest income and other drivers of our results;

 

   

assumptions related to sources of liquidity, our ability to fund servicing advances and the adequacy of our financial resources;

 

   

our ability to obtain the Required Third Party Consents on a timely basis, or at all;

 

   

our ability to pay monthly dividends;

 

   

assumptions about the availability of additional portfolios of subprime and Alt-A mortgage servicing rights and our ability to acquire additional mortgage servicing assets from Ocwen Loan Servicing and others;

 

   

the performance of Ocwen on a timely basis, or at all, as mortgage servicer and our ability to add new mortgage servicing assets on terms consistent with our business and economic model;

 

   

assumptions about the effectiveness of our hedging strategy;

 

   

assumptions about the correlation between interest rates and the income we expect to generate and the valuation of our Mortgage Servicing Assets;

 

   

expectations regarding incentive fees in our Subservicing Agreement and the stability of our gross servicing margin;

 

   

the susceptibility of our mortgage servicing assets to impairment charges;

 

   

our competitive position;

 

   

uncertainty related to future government regulation;

 

   

assumptions regarding the availability of refinancing options for subprime and Alt-A borrowers;

 

   

general economic and market conditions;

 

   

assumptions regarding amount and timing of additional equity offerings; and

 

   

assumptions regarding amount and timing of additional purchases of servicing assets from Ocwen Loan Servicing.

We have based these forward-looking statements largely on our current plans, intentions, expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. We may not actually achieve the plans, intentions or expectations

 

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disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations described in the forward-looking statements that we make. We have included important factors in the cautionary statements included in this prospectus, particularly in the “Risk Factors” section, that we believe could cause actual results or events to differ materially from those expressed or implied by the forward-looking statements that we make. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. Our forward-looking statements do not reflect the potential impact of any future acquisitions of Mortgage Servicing Assets that we may make.

You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement of which this prospectus is a part completely and with the understanding that our actual future results may be materially different from what we expect. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of our ordinary shares. Unless required by law, we undertake no obligation to publicly update or revise any forward-looking statements to reflect new information or future events or otherwise.

 

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INDUSTRY DATA

Unless otherwise indicated, information contained in this prospectus concerning the mortgage servicing industry, including our general expectations and market position and market opportunity is based on information from various sources (including government and industry publications, surveys, analyses, valuations and forecasts and our internal research), assumptions that we have made (which we believe are reasonable based on those data from such sources and other similar sources) and our knowledge of the markets for our services. The projections, assumptions and estimates of our future performance and the future performance of the mortgage servicing industry are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described under “Risk Factors” and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in the estimates included in this prospectus.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from this offering will be approximately $388 million after deducting underwriting discounts and commissions and estimated offering expenses that we must pay, assuming a public offering price of $18.37 per share, which represents the closing price of the ordinary shares on The NASDAQ Global Select Market on December 17, 2012.

We intend to use the proceeds of this offering to acquire the Planned Acquisition Assets from Ocwen Loan Servicing in the Planned Acquisition. We are in discussions with Ocwen Loan Servicing regarding the composition of the Planned Acquisition Assets, but have not yet finalized the identification of the specific assets we will acquire. We expect the Planned Acquisition Assets will have similar characteristics to those Mortgage Servicing Assets acquired in the Ocwen Transactions, and that the related servicing advances, both current and future, will be eligible for funding under the Servicing Advance Facility Agreements. We have not entered into any agreement to acquire the Planned Acquisition Assets, but we expect the Planned Acquisition will be subject to the terms and conditions of the Purchase Agreement and a supplement thereto containing terms specific to the Planned Acquisition. See “The Business—Description of Purchase Agreement.” We intend to use the remaining proceeds, if any, to purchase additional Mortgage Servicing Assets from Ocwen Loan Servicing and for working capital and general corporate purposes.

We will also use our existing Servicing Advance Facility Agreements to finance the acquisition of the servicing advances related to the Planned Acquisition Assets.

Upon the consummation of the Planned Acquisition, we expect that Ocwen Loan Servicing will remain the named servicer of each mortgage servicing right until such time as the Required Third Party Consents are obtained. We are continuing to pursue the Required Third Party Consents, and we will automatically obtain legal ownership of the acquired mortgage servicing rights without any additional payment to Ocwen Loan Servicing if and when we obtain the Required Third Party Consents.

 

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DIVIDEND POLICY

We intend to declare and pay monthly cash dividends over time on our ordinary shares with the income generated from net operating cash flows. We intend to distribute at least 90% of our net income over time to our shareholders, although we are not required by law to do so. Dividends are payable to holders of record of our ordinary shares on the last business day of each such month, subject to all applicable laws, and will be paid on the tenth day of the immediately following month, or the first business day thereafter if such payment date falls on a weekend or holiday.

Since our initial public offering, we paid the following dividends, on a per share basis:

 

Record Date

  

Payment Date

  

Amount per Ordinary Share

March 30, 2012

   April 10, 2012    $0.08

April 30, 2012

   May 10, 2012    $0.10

May 31, 2012

   June 11, 2012    $0.10

June 29, 2012

   July 10, 2012    $0.10

July 31, 2012

   August 10, 2012    $0.10

August 31, 2012

   September 10, 2012    $0.10

September 28, 2012

   October 10, 2012    $0.10

October 31, 2012

   November 12, 2012    $0.11

November 30, 2012

   December 10, 2012    $0.12

The following table sets forth the record and payment dates of the dividend that has been declared by our Board of Directors, but is unpaid:

 

Record Date

  

Payment Date

  

Amount per Ordinary Share

December 31, 2012

   January 10, 2013    $0.12

Our Board of Directors has the right to rescind any declared, but unpaid dividends at any time prior to the applicable dividend payment date.

Our dividend policy is subject to certain risks and limitations. Our ability to continue to declare and pay dividends, if any, will depend on, among other things, our cash flows, our cash requirements (including requirements to service or repay our indebtedness), general economic and business conditions, our strategic plans and prospects, our financial results and condition, contractual restrictions binding on us, legal restrictions on the declaration and payment of dividends, including statutory liquidity requirements and other limitations under Cayman Islands law, and other factors that our Board of Directors considers to be relevant.

Under Cayman Islands law, we may declare cash dividends or make other distributions only out of profits lawfully available for that purpose, or out of our share premium account, which is a reserve account that holds the subscription monies over and above the nominal value of our ordinary shares paid by our shareholders (i.e., the premium for the shares issued by us), so long as we continue to have the ability to pay our debts in the ordinary course as they become due.

There can be no assurance that we will generate sufficient income from continuing operations or external sources of financing in the future, or have sufficient surplus, net profits or reserves, as the case may be, under the laws of the Cayman Islands or other jurisdictions where our subsidiaries are located, to continue to declare and pay dividends on our ordinary shares.

We are a holding company with no operations. Our subsidiaries own all of the assets that will generate income and will own the additional Mortgage Servicing Assets that we may acquire in the future, including any purchased in the Planned Acquisition. Therefore, our ability to declare and pay dividends is dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us, by dividend, distribution or otherwise. Each of our subsidiaries is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from them.

 

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In deciding whether to make a dividend payment to our shareholders, our directors must have regard to the Company’s best interests and must have due regard for our future cash requirements, as well as our present and future solvency. Our dividend policy is based upon our directors’ current assessment of our business and the environment in which we operate, and that assessment could change based on a number of factors, including competitive developments, market conditions or new growth opportunities. Our Board of Directors may, in its discretion, change our dividend policy at any time to decrease the level of dividends or entirely discontinue the payment of dividends.

 

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CAPITALIZATION

The following table sets forth our capitalization as of September 30, 2012 (in thousands of dollars, except ordinary share data):

 

   

on an actual basis; and

 

   

on an as-adjusted basis to give effect to the sale of 22,000,000 ordinary shares in this offering at the public offering price set forth on the cover page of this prospectus after deducting underwriting discounts and commissions and estimated offering expenses of approximately $15.9 million payable by us, resulting in net proceeds to us of $388 million.

The following table should be read in conjunction with “Summary Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this prospectus.

As of September 30, 2012

(in thousands, except ordinary share data)

 

     Actual     As adjusted for
this offering
 
Equity—ordinary shares, $0.01 par value; 200,000,000 shares authorized; 30,584,718 shares (actual) and 52,584,718 shares (as adjusted) issued and outstanding at September 30, 2012    $ 306      $ 526   

Additional paid-in-capital

     415,155        803,177   

Retained Earnings

     3,889        3,889   

Accumulated other comprehensive loss

     (1,363     (1,363
  

 

 

   

 

 

 

Total equity

   $ 417,987      $ 806,229   
  

 

 

   

 

 

 

Total capitalization

   $ 1,702,905      $ 2,091,147   
  

 

 

   

 

 

 

A $1.00 increase (decrease) in the assumed public offering price of $18.37 per share would increase (decrease) the adjusted amounts of each of additional paid-in capital, total equity and total capitalization by approximately $21.2 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses.

 

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THE MORTGAGE SERVICING INDUSTRY

Overview

Over the last few decades the complexity of the market for residential mortgage loans in the United States has dramatically increased. A borrower seeking credit for a home purchase will typically obtain financing from a financial institution, such as a bank, savings association or credit union. In the past, these institutions would generally have held a majority of their originated mortgage loans as interest-earning assets on their balance sheets and would have performed all activities associated with servicing the loans, including accepting principal and interest payments, making advances for real estate taxes and property and casualty insurance premiums, initiating collection actions for delinquent payments and conducting foreclosures.

Now, institutions that originate mortgage loans generally hold a smaller portion of such loans as assets on their balance sheets and instead sell a significant portion of the loans they originate to third parties. Fannie Mae and Freddie Mac are currently the largest purchasers of home mortgage loans. Under a process known as securitization, the GSEs and financial institutions typically package residential mortgage loans into pools that are sold to securitization trusts. These securitization trusts fund the acquisition of mortgage loans by issuing securities, known as mortgage-backed securities that entitle the owner of such securities to receive a portion of the interest and principal collected on the mortgage loans in the pool. The purchasers of the mortgage-backed securities are typically large institutions, such as pension funds, mutual funds and insurance companies. The agreement that governs the packaging of mortgage loans into a pool, the servicing of such mortgage loans and the terms of the mortgage-backed securities issued by the securitization trust is often referred to as a pooling and servicing agreement.

The following chart shows the growth in residential mortgage loans that have been securitized over the past ten years. This drove an increase in the number of residential mortgage loans outstanding until the credit dislocation in 2007 reduced origination and securitization activities, particularly for subprime and Alt-A mortgage loans.

 

LOGO

Sources: CPR CDR Technologies, Inc., LoanPerformance, Inc. and Inside Mortgage Finance.

In connection with a securitization, a number of entities perform specific roles with respect to the mortgage loans in a pool, including the trustee and the mortgage servicer. The trustee holds legal title to the mortgage loans on behalf of the owner of the mortgage-backed securities and either maintains the mortgage note and related documents itself or with a custodian. The trustee or a separate securities administrator for the trust receives the payments collected by the servicer on the mortgage loans and distributes them to the investors in the mortgage-backed securities pursuant to the terms of the pooling and servicing agreement. One or more other entities are appointed pursuant to the pooling and servicing agreement to service the mortgage loans. In some cases, the servicer is the same institution that originated the loan, and, in other cases, it may be a different institution. The duties of servicers for mortgage loans

 

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that have been securitized are generally discussed below under “Mortgage Servicing,” and are generally required to be performed in accordance with industry-accepted servicing practices and the terms of the mortgage note and applicable law. A servicer generally takes actions, such as foreclosure, in the name and on behalf of the trustee.

Segments of the Residential Mortgage Loan Market

The residential mortgage market is commonly divided into a number of categories based on certain mortgage loan characteristics, including the credit quality of borrowers and the types of institutions that originate or finance such loans. While there are no universally accepted definitions, the residential mortgage loan market is commonly divided by market participants into the following categories.

GSE and Government Guaranteed Loans

This category of mortgage loans includes “conforming loans,” which are first lien mortgage loans issued to prime borrowers and are secured by single-family residences that meet or “conform” to the underwriting standards established by Fannie Mae or Freddie Mac. Prime borrowers are borrowers that have strong credit histories and who generally purchase their properties with at least a 10% down payment. The conforming loan limit is established by statute and currently is $417,000 with certain exceptions for high-priced real estate markets. This category also includes mortgage loans issued to borrowers that do not meet conforming loan standards, but who qualify for a loan that is insured or guaranteed by the government through Ginnie Mae, primarily through federal programs operated by the Federal Housing Administration and the Department of Veterans Affairs.

Non-GSE or Government Guaranteed Loans

Residential mortgage loans that are not guaranteed by the GSEs or the government are generally referred to as “non-conforming loans” and fall into one of the following categories: jumbo, subprime, Alt-A or second lien loans.

Jumbo.    Jumbo mortgage loans have original principal amounts that exceed the statutory conforming limit for GSE loans. Jumbo borrowers generally have strong credit histories and provide full loan documentation, including verification of income and assets.

Subprime.    Subprime mortgage loans are generally issued to borrowers with blemished credit histories, who make low or no down payments on the properties they purchase or have limited documentation of their income or assets. Subprime borrowers generally pay higher interest rates and fees than prime borrowers.

Alt-A.     Alt-A mortgage loans are generally issued to borrowers with risk profiles that fall between prime and subprime. These loans have one or more high-risk features, such as the borrower having a high debt-to-income ratio, limited documentation verifying the borrower’s income or assets, or the option of making monthly payments that are lower than required for a fully amortizing loan. Alt-A mortgage loans generally have interest rates that fall between the interest rates on conforming loans and subprime loans.

Second Lien.    Second mortgages and home equity lines are often referred to as second liens and fall into a separate category of the residential mortgage market. These loans typically have higher interest rates than loans secured by first liens because the lender generally will only receive proceeds from a foreclosure of a property after the first lien holder is paid in full. In addition, these loans often feature higher loan-to-value ratios and are less secure than first lien mortgages.

 

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Since the economic crisis began in 2007, the origination of jumbo, subprime, Alt-A and second lien mortgage loans has dramatically declined, and the primary market for securitizations of such loans has largely closed. The refinancing of subprime and Alt-A mortgage loans has declined in tandem with loan originations. Decreased refinancing activity for subprime and Alt-A borrowers has resulted in lower prepayment speeds and an increase in the life of the related mortgage servicing rights.

 

LOGO

Source: Inside Mortgage Finance.

Mortgage Servicing

The largest mortgage loan servicers are large banks and other financial institutions that are active in mortgage loan originations and which typically have access to deposit-based funding. Other mortgage servicers include entities that focus primarily on servicing and typically do not have access to deposit-based funding. These mortgage servicers primarily service loans held by securitization trusts that do not have the infrastructure to service loans themselves. Recent legislative and regulatory developments may have an effect on the mortgage servicing industry in various jurisdictions. Reforms in the area generally add new prohibitions or requirements. In addition, Basel III, which is scheduled to be implemented into law in several countries on January 1, 2013, includes rules that could effectively raise a bank’s regulatory capital costs of owning mortgage servicing rights. Developments such as these could potentially cause institutions to decrease the amount of mortgage servicing rights that they own. The following table shows the top residential mortgage loan servicers ranked by the unpaid principal balance of the loans serviced as of June 30, 2012:

 

Top Residential Mortgage Servicers by Unpaid Principal Balance

 
(dollars in billions)  

Servicer

   June 30, 2012     

Servicer

   June 30, 2012  

Wells Fargo

   $ 1,863      

PNC

   $ 132   

Bank of America

     1,598      

Ocwen Financial Corp.

     123   

Chase

     1,078      

BB&T

     98   

Citi

     494      

HSBC

     94   

US Bank

     254      

Walter

     86   

ResCap

     190      

MetLife

     84   

Nationstar Mortgage

     188      

Flagstar Bank

     82   

PHH

     185      

OneWest

     77   

SunTrust

     152      

Fifth Third

     75   

Ally

     139      

Capital One

     69   

 

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Servicing Activities

Residential mortgage loan servicers manage the billing, collections and loss mitigation activities associated with mortgage loans that are originated by banks or other lenders. Servicers send borrowers monthly account statements, collect monthly mortgage payments, remit such payments to the owner of the mortgage loan, answer customer service inquiries and maintain custodial accounts to hold borrower payments of principal and interest and amounts received from borrowers to pay real estate taxes and insurance with respect to the properties securing the mortgage loans and pay such real estate taxes and insurance premiums from the custodial accounts. A servicer will also remit collections on the mortgage loans from the custodial accounts to the trustee of the applicable securitization trust to make payments on the related mortgage-backed securities and prepare and deliver monthly and annual reports to the trustee. A servicer may also be required to advance its own funds to cover shortfalls in collections of principal and interest from borrowers, to pay property and casualty insurance premiums and real estate taxes on a property and to cover the costs associated with protecting or foreclosing on a property. If borrowers become delinquent on loans, the servicer generally may conduct loss mitigation activities to reduce loan delinquencies and losses by working with borrowers to collect payments and modify loans or enforce the lenders’ remedies, which may include initiating foreclose procedures and selling the properties.

Servicing Fees

Mortgage servicers receive a monthly servicing fee, which is usually based on a percentage of the mortgage loan’s unpaid principal balance per annum and typically ranges from 25 to 50 basis points depending on the categories of mortgage loans comprising the loan portfolio. Subprime servicers typically receive a servicing fee at the higher end of this range to compensate for the additional costs incurred in connection with higher delinquencies experienced with respect to subprime borrowers. Mortgage servicers usually also have the right to receive ancillary fees relating to the servicing of the mortgage loans, such as late fees from borrowers and interest earned on custodial accounts. All costs incurred by the servicer in connection with performing its servicing functions, including its obligations to make servicing advances, are generally borne by the servicer.

Servicing Advances

Servicing advances generally fall into one of three categories:

 

   

“Principal and Interest Advances” are cash payments made by the servicer to the owner of the mortgage loan to cover scheduled payments of principal and interest on a mortgage loan that have not been paid on a timely basis by the borrower.

 

   

“Taxes and Insurance Advances” are cash payments made by the servicer to third parties on behalf of the borrower for real estate taxes and insurance premiums on the property that have not been paid on a timely basis by the borrower.

 

   

“Corporate Advances” are cash payments made by the servicer to third parties for the costs and expenses incurred in connection with the foreclosure, preservation and sale of the mortgaged property, including attorneys’ and other professional fees.

Servicing advances are structured to provide liquidity to the mortgage loan securitizations but are not intended to provide credit support to the owner of the mortgage loan or the underlying borrowers. Servicing advances are usually reimbursed from amounts received with respect to the related mortgage loan, including payments from the borrower or amounts received from the liquidation of the property securing the loan, which is referred to as “loan level recovery.” Servicers generally have the right to cease making servicing advances on a loan if they determine that advances cannot be recovered at the loan level. These determinations are made by each servicer in accordance with its stop advance policy and may vary among servicers. In the event that loan level recovery is not sufficient to reimburse the servicer in full for servicing advances made with respect to a mortgage loan, most pooling and servicing agreements provide that the

 

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servicer is entitled to be reimbursed from collections received with respect to other loans in the same securitized mortgage pool, which is referred to as “pool level recovery.” The servicer generally does not receive interest on servicing advances.

The Foreclosure Process

If a borrower defaults on a mortgage loan, the owner of the mortgage loan, or the servicer on its behalf, is entitled to foreclose the property in order to sell it to repay the loan. The foreclosure process is generally initiated when the loan becomes 90 days or more delinquent.

State foreclosure laws establish certain procedures that servicers must follow in conducting foreclosures and establish minimum time periods for various aspects of the foreclosure process. These laws and their associated timelines vary widely by state. States generally follow one of two methods for their foreclosure process: judicial, with a judge presiding over the process in a court proceeding; or statutory, with the process being conducted outside the courtroom in accordance with state law. Foreclosure proceedings generally take longer and are more costly to complete in states that follow the judicial foreclosure process, primarily because of the additional legal work involved. As of September 30, 2012, 20 states used a statutory process, 23 states used a judicial process and seven states provide the servicer with the option of selecting either approach.

Foreclosure timelines increase as the number of delinquent mortgage loans increase. In addition, various state banking regulators and attorneys general have publicly announced that they have initiated inquiries into banks and servicers regarding compliance with legal procedures in connection with mortgage foreclosures and, in the case of the Joint Federal-State Servicing Settlement, have entered into a settlement in connection with mortgage foreclosure issues. These activities raise the possibility that governmental authorities, including regulators and judicial bodies, could implement further measures, including foreclosure moratoria, that could further increase foreclosure timelines. All else being equal, an increase in foreclosure timelines would adversely affect servicers by lengthening the amount of time that servicing advances are outstanding and, consequentially, increasing the financing costs related to those servicing advances. See “Risk Factors—Risks Related to Government Regulation—Regulatory scrutiny regarding foreclosure processes could lengthen foreclosure timelines or increase prepayment speeds which would negatively impact our liquidity and profitability.”

Foreclosure Alternatives

The owner of a mortgage loan, or the servicer acting on its behalf, may elect to remediate borrower delinquencies through loss mitigation and home retention strategies that fall short of foreclosure. Under the terms of many pooling and servicing agreements, mortgage servicers are permitted, on behalf of the owner of the mortgage loan, to negotiate with a borrower to modify the terms of the loan. These modifications can include principal forgiveness, maturity extensions, delinquent interest capitalization and changes to contractual interest rates. In addition, a servicer can agree to modifications upon the liquidation of a loan, commonly known as a short sale, where a portion of the outstanding principal of the loan is forgiven as part of a sale of the underlying property to a third party, or the owner of the mortgage loan can take possession of the underlying property and suspend the foreclosure with the consent of the borrower, a process commonly known as a deed-in-lieu of foreclosure. Certain governmental and agency-sponsored programs, including the Home Affordable Modification Program (“HAMP”), also provide economic incentives for servicers to implement strategies to avoid or delay foreclosures.

Effective June 1, 2012, HAMP was extended through December 2013 (“HAMP2”) and expanded to include “Tier 2” loan modifications which cover: homeowners who are applying for a modification on a home that is not their primary residence, but the property is rented or intended for rental; homeowners who previously did not qualify for HAMP because their debt-to-income ratio was 31% or lower; homeowners who previously received a HAMP trial period plan, but defaulted in their payments; and homeowners who previously received a HAMP permanent modification, but defaulted in their payments. Therefore, HAMP 2 expands the pool of loans eligible for loan modification.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

This management’s discussion and analysis of financial condition and results of operations contains forward-looking statements that involve assumptions, risks and uncertainties. See “Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. You should read the following discussion together with our consolidated financial statements and the notes thereto appearing elsewhere in this prospectus as well as the rest of the information in this prospectus, including “Summary Consolidated Financial Data” and “Capitalization.” Unless otherwise noted, all dollar amounts are in thousands.

Overview

We were incorporated as a Cayman Islands exempted company on December 1, 2010, and our operations prior to our initial public offering were limited to negotiating and entering into the Purchase Agreement and the Subservicing Agreement with Ocwen Loan Servicing on February 10, 2012, negotiating and entering into arrangements with lenders and other third parties to effect the transfer of Mortgage Servicing Assets, associated servicing advances and the related match funded liabilities to us, negotiating and entering into professional and administrative services agreements with Ocwen Loan Servicing and Altisource, and general corporate functions. We have no historical financial statements reflecting our operations prior to our inception, and our balance sheet as of December 31, 2011 and the results of our operations for the period from December 1, 2010 through December 31, 2011 reflect only the activities described above.

On March 5, 2012, we launched operations using proceeds from our initial public offering and a concurrent private placement with our founder and Chairman of our Board of Directors to acquire mortgage servicing assets related to a portfolio with $15.2 billion of unpaid principal balance of underlying mortgage loans from Ocwen.

We also assumed a related match funded servicing advance financing facility from Ocwen effective upon the closing of the Initial Ocwen Purchase. At closing on March 5, 2012, we paid cash of $149.8 million to Ocwen for the estimated purchase price of the Initial Purchased Assets (net of assumed liabilities), subject to certain closing adjustments. The purchase price for the Rights to MSRs was based on the value of such assets at the time we entered into the Purchase Agreement and the estimated outstanding unpaid principal balance of the underlying mortgage loans at closing. The purchase price for the associated servicing advances and other assets was equal to the net consolidated book value, which approximated fair value, as of the purchase date of all assets and liabilities of the subsidiary and special purpose entity established in connection with the advance financing facility that owns these servicing advances. On March 31, 2012, we and Ocwen, pursuant to the terms of the Purchase Agreement, agreed to a final purchase price of $138.8 million for the Initial Purchased Assets (net of assumed liabilities of $359.2 million), reflecting post-closing adjustments of $11.0 million that principally resulted from declines in match funded advances.

Having achieved our business and financial objectives in the first quarter, on May 1, 2012 we purchased additional mortgage servicing assets from Ocwen Loan Servicing that were substantially similar to our initial portfolio under substantially similar terms. The final purchase price for the transaction was $103.4 million (initially $103.8 million; but was subsequently adjusted). To finance that amount, we used $25.9 million in cash and borrowed $77.9 million under the Servicing Advance Facility against the $92.6 million in servicing advances associated with the Rights to MSRs.

During the quarter ended September 30, 2012, we made three additional purchases of mortgage servicing assets from Ocwen Loan Servicing. On August 1, 2012, we completed the Flow Two Purchase which resulted in the acquisition by us of Rights to MSRs with approximately $2.1 billion in unpaid principal balance as of July 31, 2012. The initial purchase price for the Flow Two Purchase was $74.7 million. To finance that amount, we used $18.6 million in cash generated from our operations and borrowed

 

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$56.1 million under the Servicing Advance Facility against the $66.7 million in servicing advances associated with the Rights to MSRs. The final purchase price was $76.2 million which reflected a $1.5 million adjustment for updated match funded advances and Notes Receivable—Rights to MSRs balances.

On September 13, 2012, we completed the First Follow On Offering Purchase which resulted in the acquisition by us of Rights to MSRs with approximately $21.1 billion in unpaid principal balance as of September 12, 2012. The initial purchase price for the First Follow On Offering Purchase was $793.0 million. To finance the purchase price, we used $202.5 million in proceeds from the Follow On Offering and $590.5 million in cash borrowed under the Servicing Advance Facility against the $707.5 million in servicing advances associated with the Rights to MSRs. The final purchase price was $788.2 million, which reflected a $4.8 million adjustment for revised match funded advance balances.

On September 28, 2012, we completed the Second Follow On Offering which resulted in the acquisition by us of Rights to MSRs with approximately $6.7 billion in unpaid principal balance as of September 27, 2012. The initial purchase price for the Second Follow On Offering Purchase was $238.1 million. To finance the purchase price, we used $30.6 million of the net proceeds from the Follow On Offering and borrowed $207.5 million under the Servicing Advance Facility. The final purchase price was $242.4 million which reflected a $4.3 million adjustment for updated match funded advances and Notes Receivable—Rights to MSRs balances.

On September 13, 2012, we amended and restated the servicing advance facility agreements that we originally entered into simultaneously with the closing of our initial public offering and the Initial Ocwen Purchase to (i) add Wells Fargo Securities, LLC as an administrative agent, (ii) create a master trust (the “Trust”) that can issue multiple series of notes with varying maturity dates and credit ratings ranging from AAA to BBB, including 2a-7 money market eligible notes and medium term notes and (iii) allow for deferred servicing fees to be included in the borrowing base as principal and interest advances for pooling and servicing agreements that meet certain conditions. This resulted in a reduced cost of our financing.

In connection with the closing of the first of the Follow On Offering Purchases, pursuant to the series 2012-MM1 indenture supplement, the Trust issued a $265 million Rule 2a-7 money market eligible note with a one-year term and a fixed interest rate per annum of 0.65%. The Trust also issued a “Class A” draw note with an expected two-year term and a variable interest rate of one month LIBOR + 200 bps. On September 28, 2012, in connection with the closing of the second of the Follow On Offering Purchases, the Trust issued a $28.5 million Class B note with a two-year term and a fixed interest rate per annum of 2.75%.

Earnings for the quarter ended on September 30, 2012 exceeded dividends declared for the period by $0.7 million. Earnings included a $0.6 million benefit from reduced amortization due to the deferral of certain modifications as Ocwen tested delinquent loans for HAMP 2 eligibility, and ending the quarter on a Sunday delayed the receipt of certain loan payoffs. These factors combined to reduce the annualized prepayment rate to 12.6% from 15.2% in the second quarter. We are seeing increased loan modifications and payoff collections subsequent to September 30, 2012, and, accordingly, we expect to see a rebound in the prepayment rate in the fourth quarter which would increase amortization on a relative basis.

We intend to continue to acquire additional substantially similar mortgage servicing assets from Ocwen in the near term in two ways:

 

   

In order to remain fully invested and to offset the impact of prepayments in our servicing portfolio, we expect to continue to utilize cash flow from operations in excess of our dividend to purchase mortgage servicing assets that are similar to our initial portfolio from Ocwen Loan Servicing under substantially similar terms. We refer to such transactions as flow transactions, which we expect to take place at regular intervals. Certain terms of such flow transactions, including the servicing incentive fee and advance ratio targets, will vary from transaction to transaction. We expect to be able to maintain or moderately grow the size of our servicing portfolio over time through these transactions.

 

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In order to increase the scale of our business we will look for opportunities to issue additional equity in the form of ordinary shares to allow us to execute larger purchases of mortgage servicing assets similar to our initial portfolio from Ocwen under similar terms. These follow on purchases will be subject to equity market conditions and will likely require that additional advance financing capacity be arranged in advance or concurrent with each transaction in order to maintain leverage similar to our current level.

Ocwen stated that as of September 30, 2012, it has servicing assets with over $63.8 billion of unpaid principal balance of underlying mortgage loans that are similar to the assets that we purchased in the transactions described above. In addition, in connection with Ocwen’s announced acquisition of Homeward Residential Holdings, Inc. and Ocwen Loan Servicing’s announced acquisition of certain assets of Residential Capital, LLC, Ocwen and Ocwen Loan Servicing are anticipated to acquire rights to service mortgage loans with approximately $120.0 billion of unpaid principal balance that are similar to those in our current portfolio. We believe the existing Ocwen servicing assets as well as the additional assets related to the Ocwen pending acquisitions potentially provide a strong pipeline of servicing assets, which could help grow our servicing portfolio. We believe that Ocwen perceives that it has benefited from the transfer of Rights to MSRs to us in connection with our previous acquisition transactions. Although we cannot guarantee that future acquisition transactions will occur, we also believe that Ocwen will benefit from such transactions and therefore will continue to sell mortgage servicing assets to us in this manner which will allow us to maintain or grow the unpaid principal balance of our servicing portfolio.

We remain open to purchasing assets from third parties other than Ocwen, but given the large amount of servicing assets available through Ocwen Loan Servicing, we do not view initiating purchases from other third parties as a near-term priority. Should Ocwen be unwilling or unable to sell mortgage servicing assets to us in the near future, we expect that there will continue to be opportunities to purchase mortgage servicing assets from other parties.

We intend to use the proceeds from this offering to purchase the Planned Acquisition Assets from Ocwen Loan Servicing in the Planned Acquisition. We are in discussions with Ocwen Loan Servicing regarding the composition of the Planned Acquisition Assets, but have not yet identified the specific assets we will acquire. We expect the Planned Acquisition Assets will have similar characteristics to those Mortgage Servicing Assets acquired in the Ocwen Transactions, and that the related servicing advances, both current and future, will be eligible for funding under the Servicing Advance Facility Agreements. The closing of this offering is not conditioned upon the completion of the Planned Acquisition. We will also use our existing Servicing Advance Facility Agreements to finance the acquisition of the servicing advances related to the Planned Acquisition Assets.

A continued strategic priority for us is to receive the consents necessary for us to become the named servicer for the securitizations where we currently own Rights to MSRs and the associated servicing advances. Although no specific time frame was provided by the rating agency, we believe that it will be up to at least one year from the closing of our initial public offering before the rating agency will consider issuing a rating confirmation. Based on our current dialogue with consent parties, our near term goal in pursuit of such consents is to establish an operating history that demonstrates a continued capability to perform the servicing requirements, specifically our obligation to fund servicing advances and to make principal and interest remittances in conformity with all requirements of the pooling and servicing agreements.

 

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Primary Components of Income

Our operations involve the acquisition and ownership of Purchased Assets. We account for the Rights to MSRs related to the Acquired Mortgage Servicing Rights as financial assets. Ocwen Loan Servicing remains obligated to service the mortgage loans underlying the Acquired Mortgage Servicing Rights pursuant to the related pooling and servicing agreements until all Required Third Party Consents are obtained and legal ownership of the Acquired Mortgage Servicing Rights is transferred to us. At that time, we will become contractually obligated to service those mortgage loans and generally to perform the functions described under “The Mortgage Servicing Industry—Mortgage Servicing—Servicing Activities.” Upon receiving the Required Third Party Consents related to an Acquired Mortgage Servicing Right, we will account for the related Right to MSRs as a servicing asset. We do not intend to develop a mortgage servicing platform if and when we acquire legal ownership of any mortgage servicing rights, nor do we intend to acquire or maintain mortgage servicing platforms, personnel or processes in connection with the acquisition of the Aggregate Purchased Assets and any Mortgage Servicing Assets we may purchase in the future. As a result, we have engaged Ocwen Loan Servicing to perform substantially all of the servicing functions relating to the Aggregate Purchased Assets on our behalf if and when we acquire legal ownership of the Acquired Mortgage Servicing Rights; however, we will not delegate to Ocwen Loan Servicing the responsibility for maintaining custodial accounts, remitting amounts from the custodial accounts and funding servicing advances pursuant to the terms of the pooling and servicing agreements, which are functions we will perform. We will employ the number of personnel necessary to manage our retained obligations with respect to those Mortgage Servicing Assets that we own.

The primary components of our net income, as determined under U.S. Generally Accepted Accounting Principles, are:

 

   

interest income (prior to receiving the Required Third Party Consents);

 

   

servicing fee revenue (subsequent to receiving the Required Third Party Consents);

 

   

fees payable to Ocwen Loan Servicing (subsequent to receiving the Required Third Party Consents);

 

   

expenses related to the amortization of our Mortgage Servicing Rights (subsequent to receiving the Required Third Party Consents);

 

   

interest expense incurred on the match funded liabilities used to finance servicing advances;

 

   

other income, including fees we receive for services that we provide to Ocwen under the Ocwen Professional Services Agreement and interest income on collected but unremitted borrower payments and loan payoff receipts and amounts held for the payment of real estate taxes and insurance premiums in custodial accounts; and

 

   

general and administrative expenses.

Interest Income—Notes Receivable (prior to receiving the Required Third Party Consents)

Our primary source of income prior to receiving the Required Third Party Consents is interest income on the Notes Receivable—Rights to MSRs. This interest income represents the amount of the servicing and other related fees collected by Ocwen Loan Servicing on the underlying Acquired Mortgage Servicing Rights (see “—Servicing Fees”) less any amounts due to Ocwen Loan Servicing for its services under the Purchase Agreement (see “—Fees to Ocwen Loan Servicing and Gross Servicing Margin”) and the amount of amortization of the Notes Receivable—Rights to MSRs (see “—Amortization of Mortgage Servicing Rights”). Upon receipt of each Required Third Party Consent related to an Acquired Mortgage Servicing Right, we will account for the Notes Receivable—Rights to MSRs balance related to such Acquired Mortgage Servicing Right as a mortgage servicing right and will begin recording servicing fee revenue related to the mortgage servicing right rather than interest income on the notes receivable.

 

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Servicing Fees

Our primary source of revenue is the fees we are entitled to receive in connection with the servicing of mortgage loans. Prior to receiving the Required Third Party Consents, the servicing fees we earn will be accounted for as a component of interest income. The pooling and servicing agreements relating to the Acquired Mortgage Servicing Rights generally entitle the servicer to an annual fee of 50 basis points of the unpaid principal balance of the mortgage loans serviced. In connection with the sale of Mortgage Servicing Assets to us, Ocwen Loan Servicing will remit to us the servicing fees related to the Acquired Mortgage Servicing Rights it recognizes in each month. If and when we acquire legal ownership of the Acquired Mortgage Servicing Rights, we will be contractually entitled to receive and retain these servicing fees directly.

The pooling and servicing agreements relating to the Acquired Mortgage Servicing Rights entitle the servicer to certain revenue streams, including late fees, prepayment fees, government incentive payments and other ancillary revenue. Ocwen Loan Servicing will not transfer the right to receive this ancillary revenue to us as part of the Rights to MSRs, but instead will retain these ancillary revenue streams. If and when the Acquired Mortgage Servicing Rights are transferred to us, we will be entitled to all ancillary servicing fees under the pooling and servicing agreements related to the Acquired Mortgage Servicing Rights; however, under the terms of the Subservicing Agreement, Ocwen Loan Servicing will retain such ancillary fees.

We recognize servicing fees as revenue as mortgage principal and interest payments are received from borrowers and as delinquent loans are brought current, modified, liquidated or charged off. Servicing fees are considered a senior obligation of the securitization trusts to which they relate which means such fees are senior to the payment of principal and interest to holders of mortgage-backed securities and represent a very small proportion of the total cash flows of the pool of mortgage loans; therefore, the risk of non-collection by the servicer is remote.

Fees to Ocwen Loan Servicing and Gross Servicing Margin

We define our gross servicing margin as the servicing fee revenue that we recognize less the fees that we pay to Ocwen Loan Servicing and any subservicers that we may engage. The manner in which we calculate the fees we pay to Ocwen Loan Servicing is the same under both the Purchase Agreement, with respect to the Rights to MSRs, and under the Subservicing Agreement, with respect to any Acquired Mortgage Servicing Right for which legal ownership has been transferred to us upon receipt of the Required Third Party Consents. However, prior to obtaining the Required Third Party Consents, these amounts will be accounted for as a component of interest income.

We pay Ocwen Loan Servicing a monthly base fee equal in the aggregate to 12% of the servicing fee revenue recognized for that month with respect to the Acquired Mortgage Servicing Rights or the related Rights to MSRs, as applicable. The monthly base fee payable to Ocwen Loan Servicing is expressed as a percentage of the servicing fee revenue actually collected in any given month, which varies from month to month based on the level of collections of principal and interest for the mortgage loans serviced. This monthly base fee structure is intended to correlate the revenue we earn with the fees we pay.

In addition to the monthly base fee, Ocwen Loan Servicing may also receive a monthly performance based incentive fee. Ocwen Loan Servicing receives this incentive fee to the extent the servicing fee revenue recognized for a given month exceeds the sum of the base fee and the amount initially retained by us (the “retained fee”), which is equal to a weighted average of 9.85 basis points of the average unpaid principal balance of the related mortgage loans, for the month of September 2012, and which will vary over the term of the related Sale Supplement or Subservicing Supplement, as applicable. The percentage used to calculate the retained fee will change over the term of each related supplement in accordance with a predetermined schedule. If we do not receive an amount equal to the retained fee in any given month, as expressed in terms of basis points of the average unpaid principal balance of the mortgage loans serviced, a shortfall in our targeted gross servicing margin percentage will occur. Ocwen Loan Servicing will not earn

 

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any performance based incentive fees for any month that there is such a shortfall, or in any subsequent month, until we have recovered such shortfall from amounts that would otherwise be available to pay future performance based incentive fees to Ocwen Loan Servicing.

The performance based incentive fee payable in any month is reduced if the ratio of outstanding servicing advances to the unpaid principal balance of the mortgage loans serviced (the “advance ratio”) exceeds a predetermined level for that month. If the advance ratio is exceeded in any month, any performance based incentive fee payable for such month will be reduced by an amount equal to 6.5% per annum of such excess servicing advances.

The fees are calculated monthly and paid by us to Ocwen Loan Servicing within three business days of the final day of each month. The base fees and the performance based incentive fees are subject to change upon any renewal of the subservicing supplement relating to the Mortgage Servicing Assets purchased from Ocwen. The fees with respect to future pools of mortgage loans will be as agreed by us and Ocwen Loan Servicing in the agreements entered into in connection with the future acquisition of the related Mortgage Servicing Assets.

The gross servicing margin is expected (i) to cover our operating costs, which are principally comprised of amortization of mortgage servicing rights, interest expense incurred to finance servicing advances and administrative and other expenses and (ii) to be sufficient to allow us to pay our targeted dividends. We believe that the structure of these fees as described above will align the interests of both companies and help us meet our performance targets.

Amortization of Mortgage Servicing Rights

We will record our mortgage servicing rights at their acquisition cost which is the same as their fair value. Prior to receiving the Required Third Party Consents related to the Acquired Mortgage Servicing Rights, we will amortize the Notes Receivable—Rights to MSRs using the prospective interest method of accounting. At each reporting date, we will calculate the present value of the net cash flows related to the underlying Acquired Mortgage Servicing Rights and adjust the carrying value of the Notes Receivable—Rights to MSRs to this amount. The change in the value of the Notes Receivable—Rights to MSRs will be deducted from the net of the servicing fees received from the Acquired Mortgage Servicing Rights and the servicing fees paid to Ocwen Loan Servicing, and the resulting amount will be recorded as interest income.

Prepayment speeds are a significant driver of changes in estimated net servicing income, mortgage servicing rights amortization expense and the balance of the Notes Receivable—Rights to MSRs. Prepayment speeds relating to subprime and Alt-A mortgage loans have not historically shown a high degree of volatility from one period to the next. Therefore, we expect amortization rates to remain relatively stable over time.

Interest Expense

Servicing advances are primarily financed through the use of match funded liabilities that accrue interest. Interest expense also includes amortization of deferred financing costs, non-use fees and any hedge related costs.

When a borrower is delinquent, the amount of cash that is required to be advanced to the trustee or other owner of the mortgage loan on behalf of the borrower increases. We incur significant interest costs to finance such advances. As a result, increased delinquencies result in increased interest expense without respect to any change in interest rates. The speed at which delinquent loans are resolved affect our interest expense. For example, slower resolution of delinquencies result in higher servicing advance balances and interest expense.

We have executed a hedging strategy designed to largely neutralize the impact of increases in interest rates over specified time periods. Our objective is to utilize hedges in an amount equal to our net exposure to interest rate increases on our match funded liabilities, which bear interest at floating interest rates, after

 

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taking into account our expected float balances which partially offset the impact of rising interest rates. If interest rates decline, the value of our hedges will decline. Should our hedging strategy prove ineffective or if we were not able to hedge all of our interest rate risk, rising interest rates would lead to higher interest expense. See “Risk Factors—Risks Related to Our Business and Industry—Our hedging strategies may not be successful in mitigating the risks associated with changes in interest rates” and “—Liquidity and Capital Resources.”

Other Income

Other income consists of amounts due to us from Ocwen under the terms of the Ocwen Professional Services Agreement and float earnings. Under the Ocwen Professional Services Agreement, we receive revenue for providing certain services to Ocwen, which includes valuation and analysis of mortgage servicing rights, advance financing management, treasury management, legal services and other similar services.

Float earnings consist of interest earned on mortgage loan payments and payoff collections that have been collected but which have not yet been remitted to the securitization trust that owns the mortgage loan or which are owed to pay real estate taxes and insurance premiums with respect to the related mortgaged properties. Mortgage loan payments are usually due from the borrower between the first and fifteenth days of the month and are usually remitted to the securitization trust between the eighteenth and twenty-fourth days of each month. Until these funds are remitted to the securitization trust, they reside in interest bearing custodial accounts controlled by the servicer and are invested in accordance with the pooling and servicing agreements and our investment policy. In some cases, this interest income may be reduced by fees for account maintenance or transaction processing or interest due to borrowers on amounts held in custodial accounts. Pursuant to the Purchase Agreement, we are entitled to receive from Ocwen Loan Servicing any float earnings related to the Rights to MSRs even though we will not have custody of the custodial accounts until such time as legal ownership of the related Acquired Mortgage Servicing Rights is transferred to us.

Administrative and Other Expense

Administrative and other expenses consist largely of salaries, bonuses and related payroll taxes and employee benefit costs for our employees. In addition, we incur expenses for facilities, technology, communication and other expenses typical of public companies, including audit, legal and other professional fees. Some of our administrative services are provided pursuant to the Altisource Administrative Services Agreement as discussed in “—Related Party Transactions.” In addition, to the extent that we evaluate and/or complete acquisitions of Mortgage Servicing Assets in the future, we will incur additional expenses, most of which we do not expect to capitalize. Administrative and other expenses include expenses related to the services we provide to Ocwen, and the services provided by Ocwen to us, under the Ocwen Professional Services Agreement. See “—Related Party Transactions.”

Income Taxes

We are a Cayman Islands exempted company, and the Cayman Islands currently levies no taxes on individuals or corporations based on profits, income, gains or appreciation. HLSS Management, LLC, our management company that is taxed as a corporation for U.S. federal income tax purposes, will generate nominal income and will be subject to taxation in the United States. Accordingly, our consolidated effective income tax rate is and will likely continue to be substantially lower than the maximum U.S. federal income tax rate. See “Material Cayman Islands and United States Federal Income Tax Considerations.”

 

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Results of Operations

The following table summarizes our consolidated operating results for the periods ended September 30, 2012 and 2011, which includes the periods prior to March 5, 2012 when we were a development stage enterprise.

 

     Three Months
Ended
September 30,
    Nine Months
Ended
September 30,
 
     2012      2011     2012      2011  

Consolidated:

          

Revenue

   $ 14,832       $      $ 29,489       $   

Operating expenses

     1,936         38        4,307         82   
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) from operations

     12,896         (38     25,182         (82

Interest expense

     6,252                12,507           
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

     6,644         (38     12,675         (82

Income tax expense

     72                149           
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ 6,572       $ (38   $ 12,526       $ (82
  

 

 

    

 

 

   

 

 

    

 

 

 

Three Months and Nine Months Ended September 30, 2012 versus September 30, 2011.    Revenue for the three and nine months ended September 30, 2012 primarily includes interest income recorded on Notes Receivable—Rights to MSRs using the prospective interest method. Because we currently do not satisfy all of the requirements necessary to record the Rights to MSRs as a servicing asset, our Acquired Mortgage Servicing Rights were accounted for as a financing. Also included in revenue for the three and nine months ended September 30, 2012 are the amounts billed to Ocwen for services we provide under the Ocwen Professional Services Agreement and interest earned on custodial accounts and corporate account balances.

Operating expenses for the three and nine months ended September 30, 2012 increased primarily due to compensation and benefits and professional services associated with our first months of full operations. Additionally, interest expense increased significantly in both periods due to increases in match funded liabilities in connection with our asset purchases during 2012.

Income tax expense was $72 and $149 for the three and nine months ended September 30, 2012. There was no income tax expense for the three or nine months ended September 30, 2011.

Our effective tax rate was 1% for the three and nine months ended September 30, 2012. We base income tax provisions for interim periods on estimated annual income taxes calculated separately from the effect of significant, infrequent or unusual items. We are a Cayman Islands exempted company, and the Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation. Our subsidiary, HLSS Management, LLC, is the employer of all of our U.S. based employees and is a corporation for U.S. federal income tax purposes. We computed income tax expense by applying the Federal and state combined rate of 38% to the earnings of HLSS Management, LLC that are subject to U.S. federal and state income taxes.

Summary Operating Information

We operate the business as a single reportable segment. For purposes of our internal management reporting, we separately report the components of Interest income-Notes Receivable—Rights to MSRs, which include servicing fee revenue, servicing expense and amortization expense for MSRs. We provide a reconciliation of our reported results to our internal management reporting for the three and nine months ended September 30, 2012 in the following table. We did not provide reconciliations for the three and nine months ended September 30, 2011 because we were a development stage enterprise during that period, and our operations were limited to negotiating and entering into the Purchase Agreement and the Subservicing

 

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Agreement with Ocwen Loan Servicing, negotiating and entering into arrangements with lenders and other third parties to effect the transfer of our initial Mortgage Servicing Assets, associated servicing advances and the related match funded liabilities to us, negotiating and entering into professional and administrative services agreements with Ocwen Loan Servicing and Altisource, raising capital to complete the Initial Ocwen Purchase and general corporate functions. Operating items during that period consisted primarily of start-up costs and are not comparable to the three and nine months ended September 30, 2012.

We executed our agreements with Ocwen Loan Servicing with the intent that we would receive the total amount of the servicing fees collected and that we would pay Ocwen Loan Servicing a subservicing fee that is determined based on its collections and advance ratio performance. We evaluate our operating performance and manage our business considering servicing fees collected and subservicing fees paid and maintain our internal management reporting on this basis. The following table presents our condensed consolidated results of operations in accordance with U.S. GAAP reconciled to our internally reported financial results.

Our total revenue, total operating expenses and income from operations as presented in our Management Reporting shown below should be considered in addition to, and not as a substitute for: total revenue, total operating expenses and income from operations determined in accordance with GAAP.

 

     Condensed
Consolidated
Results (GAAP)
     Adjustments     Management
Reporting
(Non-GAAP)
 

For the three months ended September 30, 2012:

       

Servicing fee revenue(1)

   $       $ 27,689      $ 27,689   

Interest income-notes receivable—Rights to MSRs(2)

     14,017         (14,017       

Professional services

     669                669   

Interest income—other

     146                146   
  

 

 

    

 

 

   

 

 

 

Total revenue

     14,832         13,672        28,504   
  

 

 

    

 

 

   

 

 

 

Operating expenses

       

Compensation and benefits

     1,257                1,257   

Servicing expense(3)

             10,633        10,633   

Amortization of MSRs(4)

             3,039        3,039   

General and administrative expenses

     679                679   
  

 

 

    

 

 

   

 

 

 

Total operating expenses

     1,936         13,672        15,608   
  

 

 

    

 

 

   

 

 

 

Income from operations

   $ 12,896       $      $ 12,896   
  

 

 

    

 

 

   

 

 

 

 

(1) Servicing fee revenue reflects $27,689 of servicing fees received under the agreements with Ocwen.
(2) Interest income-Notes Receivable—Rights to MSRs represents the net amount of servicing fees received less servicing fees paid and amortization of the Notes Receivable—Rights to MSRs. We exclude this interest income from our management reporting and instead report the contractual components including servicing fee revenue, servicing expense and amortization of MSRs.
(3) Servicing expense reflects the fee we paid under the agreements with Ocwen.
(4) Amortization of MSRs reflects $3,039 reduction in the value of the Notes Receivable—Rights to MSRs.

 

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     Condensed
Consolidated
Results (GAAP)
     Adjustments     Management
Reporting
(Non-GAAP)
 

For the nine months ended September 30, 2012:

       

Servicing fee revenue(1)

   $       $ 57,190      $ 57,190   

Interest income-notes receivable—Rights to MSRs(2)

     27,542         (27,542       

Professional services

     1,664                1,664   

Interest income—other

     283                283   
  

 

 

    

 

 

   

 

 

 

Total revenue

     29,489         29,648        59,137   
  

 

 

    

 

 

   

 

 

 

Operating expenses

       

Compensation and benefits

     2,682                2,682   

Servicing expense(3)

             23,093        23,093   

Amortization of MSRs(4)

             6,555        6,555   

General and administrative expenses

     1,625                1,625   
  

 

 

    

 

 

   

 

 

 

Total operating expenses

     4,307         29,648        33,955   
  

 

 

    

 

 

   

 

 

 

Income from operations

   $ 25,182       $      $ 25,182   
  

 

 

    

 

 

   

 

 

 

 

(1) Servicing fee revenue reflects $57,190 of servicing fees received under the agreements with Ocwen.
(2) Interest income-Notes Receivable—Rights to MSRs represents the net amount of servicing fees received less servicing fees paid and amortization of the Notes Receivable—Rights to MSRs. We exclude this interest income from our management reporting and instead report the contractual components including servicing fee revenue, servicing expense and amortization of MSRs.
(3) Servicing expense reflects the fee we paid under the agreements with Ocwen.
(4) Amortization of MSRs reflects $6,555 reduction in the value of the Notes Receivable—Rights to MSRs.

Three months and nine months ended September 30, 2012 versus 2011.    Servicing fee revenue increased due to our asset purchases during 2012. Servicing fee revenue is a function of principal and interest collected during the period and the contractual servicing fee rate. In accordance with the rates set forth in the sale supplements for the Initial Ocwen Purchase, the Flow One, Flow Two and Follow On Offering Purchases, our gross servicing margin (servicing fee revenue less servicing expense) was 29.9 and 30.6 basis points of average unpaid principal balance for the three and nine months ended September 30, 2012, respectively. We also earned income from professional services provided to Ocwen under the Ocwen Professional Services Agreement. We did not earn revenue in 2011 associated with these arrangements given we were a development stage organization.

Operating expenses increased for both periods because we began operations at the completion of our initial public offering and concurrent private placement and the Initial Ocwen Purchase on March 5, 2012. Operating expenses in 2012 are primarily comprised of servicing fees paid to Ocwen for servicing the Rights to MSRs, salaries and wages and professional services. The servicing fees paid to Ocwen were $3,323 and $6,863 for the base fee and $7,310 and $16,230 in incentive fees for the three and nine months ended periods, respectively. Amortization Expense relates to reductions in the unpaid principal balance due to portfolio run-off. Our average headcounts for the three months ended and nine months ended periods were twelve and eleven, respectively. Most of our employees transferred to HLSS from Ocwen at the time of closing our initial public offering and concurrent private placement and the Initial Ocwen Purchase on March 5, 2012. Expenses during the three and nine months ended September 2011 were primarily related to organization costs associated with starting our business.

 

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The following table provides selected portfolio statistics as of September 30:

 

(in thousands, except for loan count data)

   2012     2011(1)     % Change  

Residential Assets Serviced

      

Unpaid principal balance:

      

Performing loans(2)

   $ 36,257,325      $ 35,389,646        2

Non-performing loans

     9,204,862        8,008,571        15   

Non-performing real estate

     1,061,446        2,230,531        (52
  

 

 

   

 

 

   

Total residential assets serviced

   $ 46,523,633      $ 45,628,748        2   
  

 

 

   

 

 

   

Percent of total unpaid principal balance:

      

Servicing portfolio

     100.0     100.0     0   

Non-performing residential assets serviced

     22.1     22.4     (2

Number of:

      

Performing loans(2)

     264,904        256,757        3   

Non-performing loans

     47,283        40,059        18   

Non-performing real estate

     5,546        10,584        (48
  

 

 

   

 

 

   

Total number of residential assets serviced

     317,733        307,400        3   
  

 

 

   

 

 

   

Percent of total number:

      

Non-performing residential assets serviced

     16.6     16.5     1   

The following table provides selected portfolio statistics for the three months ended September 30:

 

(in thousands, except for loan count data)

   2012     2011(1)     % Change  

Average residential assets serviced

   $ 22,797,355      $ 29,186,605        (22 %) 

Prepayment speed (average CPR)

     12.6     16.1     (19

Average number of residential assets serviced

     182,332        186,269        (2

The following table provides selected portfolio statistics for the nine months ended September 30:

 

(in thousands, except for loan count data)

   2012     2011(1)     % Change  

Average residential assets serviced

   $ 16,806,681      $ 22,181,336        (24 %) 

Prepayment speed (average CPR)

     14.2     15.4     (8

Average number of residential assets serviced

     127,907        136,921        (7

 

(1) The data related to the Mortgage Servicing Rights as of (and for the periods ended) September 30, 2011 is shown for comparative purposes only. HLSS acquired the Acquired Mortgage Servicing Rights during 2012 and had no Mortgage Servicing Rights during 2011. 2011 data excludes servicing information for which Ocwen does not have historical information.
(2) Performing loans include those loans that are current or have been delinquent for less than 90 days in accordance with their original terms and those loans for which borrowers are making scheduled payments under loan modification, forbearance or bankruptcy plans. We consider all other loans to be non-performing.

The following table provides information regarding changes in our portfolio of residential assets serviced during the quarter:

 

(in thousands, except for loan count data)

   Unpaid
Principal
Balance
    Loan Count  

Servicing portfolio at June 30, 2012

   $ 17,294,385        109,890   

Additions

     29,860,255        210,175   

Runoff

     (631,007     (2,332
  

 

 

   

 

 

 

Servicing portfolio at September 30, 2012

   $ 46,523,633        317,733   
  

 

 

   

 

 

 

 

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The following table provides information regarding changes in our portfolio of residential assets serviced during 2012 from the time of the initial acquisition of mortgage servicing rights (March 5, 2012) to September 30, 2012:

 

(in thousands, except for loan count data)

   Unpaid
Principal
Balance
    Loan Count  

Servicing portfolio at March 5, 2012

   $ 15,227,283        96,162   

Additions

     32,807,544        227,089   

Runoff

     (1,511,194     (5,518
  

 

 

   

 

 

 

Servicing portfolio at September 30, 2012

   $ 46,523,633        317,733   
  

 

 

   

 

 

 

Change in Financial Condition

The overall increase in total assets of $1,699,762 and total liabilities of $1,281,784 during the nine months ended September 30, 2012 primarily resulted from:

 

   

The completion of our initial public offering and the First Follow On Offering pursuant to which we raised cash of $418,097;

 

   

The completion of five acquisitions pursuant to which we acquired assets of $1,713,397 and had associated increases in match funded liabilities of $1,290,243; and

 

   

Advance facility activity pursuant to which we received $55,788 in match funded advance remittances and paid down $39,331 of outstanding match funded liability balances.

The assets acquired in our asset acquisitions included Notes Receivable—Rights to MSRs which had a balance of $177,730 representing 10.4% of total assets at September 30, 2012. Notes Receivable—Rights to MSRs are carried at fair value, which is determined based on valuations prepared with the assistance of an independent valuation firm. The most significant assumptions used in connection with these valuations are:

 

   

Discount rates reflecting the risk of earning the future income streams ranging from 14% to 22%.

 

   

Interest rate used for calculating the cost of servicing advances of 1-Month LIBOR + 4%.

 

   

Mortgage loan prepayment projections ranging from 12% to 25% of the related mortgage lifetime projected prepayment rate.

 

   

Delinquency rate projections ranging from 15% to over 35% of the aggregate unpaid balance of the underlying mortgage loans.

The independent valuation firm reviewed the collateral attributes and the historical payment performance of the underlying mortgage servicing portfolio and compared them with similar mortgage servicing portfolios and with standard industry mortgage performance benchmarks to arrive at the assumptions set forth above. The selected collateral attributes and performance comparisons utilized were the voluntary prepayment performance, delinquency and foreclosure performance, operational cost comparison, average loan balance, weighted average coupon and note rate distribution, loan product type classification, geographic distribution and servicing advance behavior.

The unobservable inputs that have the most significant effect on the fair value of Notes Receivable—Rights to MSRs are the mortgage loan prepayment rate projections and the interest rate projections; however, any significant increase (decrease) in discount rates, interest rates, mortgage loan prepayment projections or delinquency rate projections, each in isolation, would result in a substantially lower (higher) valuation.

 

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Total equity amounted to $417,987 at September 30, 2012 as compared to $9 at December 31, 2011. This increase of $417,978 is primarily due to the proceeds of equity offerings less share issuance costs of $418,097, net income of $12,526, offset by dividends declared of $11,282. In addition, we recorded $1,363 of unrealized losses in other comprehensive loss on interest rate swaps that we designated as cash flow hedges.

Significant Assets and Liabilities

Because our business generally relates to the acquisition and financing of Mortgage Servicing Assets, the description of these assets and liabilities and of our accounting policies related to them is important to the understanding of our business. The principal assets that we acquire and liabilities that we assume on the closing dates of our acquisitions of Mortgage Servicing Assets include the Notes Receivable—Rights to MSRs related to the Acquired Mortgage Servicing Rights and the associated servicing advances and the match funded liabilities relating to the Servicing Advance Facility pursuant to which such servicing advances are financed. We will acquire legal ownership of the Acquired Mortgage Servicing Rights if and when the Required Third Party Consents are obtained.

Notes Receivable—Rights to MSRs

During the period before we receive the Required Third Party Consents related to the Acquired Mortgage Servicing Rights, we account for the purchase of the Rights to MSRs as a financing. Accordingly, we account for the amount paid to Ocwen Loan Servicing for the purchase of the Rights to MSRs as Notes Receivable—Rights to MSRs.

We will amortize the Notes Receivable—Rights to MSRs using the prospective interest method of accounting. At each reporting date, we calculate the present value of the net cash flows related to the underlying Acquired Mortgage Servicing Rights and adjust the carrying value of the Notes Receivable—Rights to MSRs to this amount. The change in the value of the Notes Receivable—Rights to MSRs will be deducted from the net of the servicing fees received from the Acquired Mortgage Servicing Rights and the servicing fees paid to Ocwen Loan Servicing, and the resulting amount will be recorded as interest income.

Mortgage Servicing Rights

If and when we obtain legal ownership of a mortgage servicing right, we will record the mortgage servicing right at the then current carrying value of the related Notes Receivable—Rights to MSRs. A mortgage servicing right is an intangible asset representing the right by the owner to service a pool of mortgage loans for a predetermined fee. The following sections discuss the accounting treatment for and valuation of mortgage servicing rights.

Mortgage Servicing Rights Valuation.    At the end of each fiscal quarter, an independent third party valuation firm will assist us in determining the fair value of our mortgage servicing rights using a valuation method that is based on the present value of their expected future cash flows utilizing assumptions that are believed to be reasonable and that are consistent with the assumptions that are used by other market participants. The most significant assumptions that will be used are estimates of the speed at which mortgages will prepay and the aggregate principal amount of mortgage loans that will become delinquent, both of which will be based on available market data. Other assumptions used in this valuation will be:

 

   

the cost of servicing;

 

   

compensating interest expense;

 

   

the discount rate reflecting the risk of earning the future income streams from our mortgage servicing rights;

 

   

the interest rate used for computing float earnings;

 

   

the interest rate used for computing the cost of servicing advances; and

 

   

the collection rate of other ancillary fees.

 

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The primary component of the estimated future cash inflows for our mortgage servicing rights is contractual servicing fees. Significant cash outflows include the cost of servicing mortgage loans, which includes the cost of financing servicing advances. The most significant assumptions used in the valuation analysis are the mortgage prepayment and delinquency rates, both of which are derived from available market data. Other assumptions used in this valuation of mortgage servicing rights are the discount rate (which reflects the risks associated with our relationship with Ocwen Loan Servicing, including that Ocwen Loan Servicing could become bankrupt, insolvent or otherwise be terminated as servicer), the interest rate used for computing the cost of the servicing advances and the cost of servicing representing industry averages. This valuation is made without regard to the owner of the mortgage servicing rights.

Changes in these assumptions would be generally expected to affect our results of operations as summarized below:

 

   

Increases in prepayment speeds generally reduce the value of our mortgage servicing rights as a result of decreased future cash flows, accelerated mortgage servicing rights amortization expense and lower overall servicing fees. These results would be partially offset by a lower cost of servicing and lower interest expense on decreased servicing advance balances.

 

   

Increases in delinquencies or foreclosures generally reduce the value of our mortgage servicing rights as the amount of servicing advances, match funded liabilities and related interest expense increase. Factors which could contribute to increases in delinquencies or foreclosures include increases in interest rates, which could increase the payments owed by borrowers on adjustable-rate mortgages, or further declines in home values generally, which could reduce the incentive for a borrower to continue to make timely payments on his or her mortgage.

 

   

Increases in the discount rate would reduce the value of our mortgage servicing rights due to the lower overall net present value of our future net cash flows.

 

   

Increases in interest rate assumptions relating to the cost of financing servicing advances would increase interest expense and reduce the value of our mortgage servicing rights.

Fair Value of Mortgage Servicing Rights.    The rate of decline in unpaid principal balance of mortgage loans is known as prepayment speed and is affected by factors such as employment rates, interest rates, housing prices, loan type and loan status. The unpaid principal balance of the related mortgage loans is the primary driver of servicing fees, subservicing expense, mortgage servicing rights amortization expense, mortgage servicing rights and servicing advance balances.

 

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The fair value of the mortgage servicing rights acquired in the Initial Ocwen Purchase and the Flow One Purchase is presented in the table below in terms of both basis points and absolute dollar amounts. For the Initial Ocwen Purchase, management has estimated the fair value of such mortgage servicing rights associated with each pooling and servicing agreement to the extent that such mortgage servicing rights were owned by Barclays during such period of time. These estimates were based on our assumptions regarding the future cash flows of such Initial Mortgage Servicing Rights at the time the valuations were performed. The fair values presented for the mortgage servicing rights acquired in the Flow One Purchase and for the Initial Purchased Assets for the period from September 30, 2010 are based on management’s beliefs regarding such values for the period of time that these mortgage servicing rights were owned by Ocwen Loan Servicing. In arriving at these estimates, management also utilized industry assumptions regarding the future cash flows of the Initial Mortgage Servicing Rights. The risks associated with our relationship with Ocwen Loan Servicing, including the risk that Ocwen Loan Servicing could become insolvent or bankrupt or otherwise be terminated as servicer, have been considered by management in determining the discount rate used to value our Mortgage Servicing Assets. Management will continue to assess these risks when determining the discount rate to be used in the valuation of our Mortgage Servicing Assets in future periods. Since unpaid principal balance, and subsequently fair value, decline as loans are repaid, refinanced or otherwise resolved, the disclosure of valuation in terms of basis points provides a comparable view of the change in economic fair value over time.

 

     Fair Value of Mortgage Servicing Rights
Acquired in the  Initial Ocwen Purchase and

the Flow One Purchase
 

Quarter Ended

   Unpaid Principal Balance      Basis Points      Amount  
     (dollars in millions)  

December 31, 2009

   $ 26,659         32.46         87   

March 31, 2010

   $ 25,366         34.11         87   

June 30, 2010

   $ 24,170         38.09         92   

September 30, 2010

   $ 22,962         37.42         86   

December 31, 2010

   $ 22,147         40.35         89   

March 31, 2011

   $ 21,237         41.79         89   

June 30, 2011

   $ 20,406         40.19         82   

September 30, 2011

   $ 19,528         38.47         75   

December 31, 2011

   $ 18,743         40.45         76   

March 31, 2012

   $ 18,026         40.37         73   

June 30, 2012

   $ 17,295         40.58         70   

September 30, 2012

   $ 16,712         40.58         68   

 

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The fair value of the mortgage servicing rights acquired in the Flow Two Purchase and the Follow On Offering Purchases is presented in the table below in terms of both basis points and absolute dollar amounts for the quarters ended June 30, 2012 and September 30, 2012. These estimates were based on our assumptions regarding the future cash flows of such Acquired Mortgage Servicing Rights at the time the valuations were performed. The fair values presented are based on management’s beliefs regarding such values for the period of time that such Acquired Mortgage Servicing Rights were owned by Ocwen Loan Servicing. Ocwen does not have complete historical information for the Flow Two Purchase and the Follow On Offering Purchases for the period from December 31, 2009 through March 31, 2012.

 

     Fair Value of Mortgage Servicing Rights
Acquired in the Flow Two Purchase and
the Follow On Offering Purchases
 

Quarter Ended

   Unpaid Principal Balance      Basis Points      Amount  
     (dollars in millions)  

June 30, 2012

   $ 30,911         36.12         112   

September 30, 2012

   $ 29,812         37.16         110   

With respect to the Planned Acquisition Assets, we expect the value of the related mortgage servicing rights to be similar–both in terms of basis points and the proportion of dollar value to unpaid principal balance–to the current values of the Acquired Mortgage Servicing Rights.

We purchased the Mortgage Servicing Assets related to the Acquired Mortgage Servicing Rights at their current fair value, which we believe reflects a significant portion of the impact of the general downward repricing of mortgage servicing rights that began in 2007. The fair value of the Acquired Mortgage Servicing Rights was $177,730 as of September 30, 2012.

Servicing Advances

Servicing advances are our largest asset class. We acquired servicing advances of approximately $1,502.2 million from Ocwen Loan Servicing in connection with the Initial Ocwen Purchase, the Flow Transactions and the Follow On Offering Purchases. The reimbursement of servicing advances is a senior obligation of the related securitization trust, which means that such reimbursement is senior to the ultimate payment of principal and interest to holders of mortgage-backed securities. All of the pooling and servicing agreements relating to the Acquired Mortgage Servicing Rights provide for loan level and pool level recoveries.

Pooling and servicing agreements generally require the servicer to advance funds to the securitization trusts that own the mortgage loans during any period in which borrowers are delinquent. The servicer is also required to fund servicing advances relating to the maintenance, repair and marketing of foreclosed properties on behalf of the securitization trust. These servicing advances are made pursuant to the terms of the pooling and servicing agreement governing the related pool of mortgage loans underlying the mortgage servicing rights.

Ocwen Loan Servicing remains contractually obligated to the trustees of the securitization trusts to make any servicing advances pursuant to the pooling and servicing agreements related to the Acquired Mortgage Servicing Rights until legal ownership of such Acquired Mortgage Servicing Rights is transferred to us. We are obligated to purchase the servicing advances made by Ocwen Loan Servicing during the period of time prior to the transfer of legal ownership of the Acquired Mortgage Servicing Rights to us, and although we are not obligated directly to the trustees of the securitization trusts to make servicing advances pursuant to the related pooling and servicing agreements, we are obligated to Ocwen Loan Servicing pursuant to the Purchase Agreement to purchase such servicing advances. When an Acquired Mortgage Servicing Right is transferred to us, we will become directly obligated to the related trustee to make any servicing advances required pursuant to the related pooling and servicing agreements.

Servicing advances are currently and will continue to be pledged as collateral under the terms of the existing advance financing facility relating to the Acquired Mortgage Servicing Rights.

 

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We value servicing advances at their face value, which is the same as their estimated fair value, because servicing advances are a senior obligation of the securitization trust that owns the mortgage loan, have no stated maturity, generally are realized within a relatively short period of time and do not bear interest.

The servicer is generally obligated to advance funds only to the extent that it believes servicing advances will be recoverable from the expected proceeds from the related mortgage loan. Pursuant to the terms of the Purchase Agreement, we are only obligated to purchase servicing advances relating to the Rights to MSRs from Ocwen Loan Servicing if and to the extent such servicing advances are made in accordance with the terms of the related pooling and servicing agreement and Ocwen Loan Servicing’s advance and stop advance policies. We believe that the likelihood of the servicer not collecting servicing advances relating to the Acquired Mortgage Servicing Rights is remote primarily due to the availability of pool level recoveries for servicing advances ultimately not recoverable at the loan level in the related pooling and servicing agreements. We record a charge to earnings to the extent that we believe any servicing advances become uncollectible under the provisions of the related pooling and servicing agreement. Ocwen Loan Servicing is required to assess the collectability of servicing advances on our behalf using its stop advance policy. In addition, Ocwen Loan Servicing must notify us of any servicing advances that we are required to purchase prior to the transfer of the Acquired Mortgage Servicing Rights to us, or that we are contractually required to make following any such transfer, pursuant to the terms of the pooling and servicing agreements and the stop advance policy. The projection models driving the stop advance policy incorporate a number of different factors depending on the characteristics of the mortgage loan or pool of loans, including time to a foreclosure sale, estimated costs of foreclosure action, future property tax payments and the estimated proceeds upon the sale of the underlying property net of carrying costs, commissions and closing costs. We periodically review and monitor Ocwen Loan Servicing’s compliance with the stop advance policy. We are entitled to recover from Ocwen Loan Servicing any servicing advance that was made in violation of the stop advance policy or that was not recoverable from the securitization trust because it violated the terms of the related pooling and servicing agreement.

The unpaid principal balance of a pool of mortgage loans and the amount of outstanding servicing advances typically decline as loan payments are received or loans are otherwise brought current, modified, liquidated or charged off. Servicing advances are typically financed, in part, by match funded liabilities and, therefore, are a principal driver of match funded liability balances and interest expense. The advance ratio is a ratio of the outstanding servicing advances to the unpaid principal balance of the related mortgage loans. The advance ratio influences match funded liabilities, interest expense and liquidity. Many factors can influence the level of servicing advances, including the following:

 

   

servicing requirements and advancing obligations under each pooling and servicing agreement;

 

   

characteristics of the underlying mortgage loans and economic conditions which drive delinquency status and prepayment speed;

 

   

foreclosure timelines;

 

   

the time required to dispose of real estate owned properties;

 

   

the servicer’s servicing efficiency; and

 

   

the servicer’s advance and stop advance policies.

Historical Servicing Advances Data

The table below sets forth the outstanding servicing advances relating to the mortgage servicing rights acquired in the Initial Ocwen Purchase and the Flow One Purchase. For $13.9 billion of the related unpaid principal balances as of September 30, 2012, HomEq Servicing was the servicer of the mortgage loans underlying the related mortgage servicing rights for the quarters ended December 31, 2009 through June 30, 2010. Accordingly, the related amounts of outstanding servicing advances and advance ratios are

 

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reflective of HomEq Servicing’s practices and policies and general economic conditions impacting the mortgage loans during that period. The amounts shown for the quarters ended September 30, 2010 and after represent the amount of outstanding servicing advances during the period in which Ocwen Loan Servicing serviced the mortgage loans underlying the related mortgage servicing rights. The decrease in the advance ratio after September 30, 2010 reflects the impact of Ocwen Loan Servicing’s servicing practices and policies and general economic conditions impacting the mortgage loans during the period. The amount of outstanding servicing advances shown below, therefore, may have been affected by factors that will not apply to the Acquired Mortgage Servicing Rights after we purchase the Rights to MSRs or after we acquire legal ownership of any related Acquired Mortgage Servicing Rights and may not be indicative of the results that we will achieve in the future.

 

Quarter Ended

   Unpaid Principal Balance      Amount of Outstanding
Servicing Advances
     Advance Ratio  
     (dollars in millions)  

December 31, 2009

   $ 26,659         1,348         5.1

March 31, 2010

   $ 25,366         1,379         5.4

June 30, 2010

   $ 24,170         1,304         5.4

September 30, 2010

   $ 22,962         1,253         5.5

December 31, 2010

   $ 22,147         1,099         5.0

March 31, 2011

   $ 21,237         897         4.2

June 30, 2011

   $ 20,406         753         3.7

September 30, 2011

   $ 19,528         642         3.3

December 31, 2011

   $ 18,743         572         3.1

March 31, 2012

   $ 18,026         505         2.8

June 30, 2012

   $ 17,295         430         2.5

September 30, 2012

   $ 16,712         421         2.5

The table below sets forth the outstanding servicing advances relating to the mortgage servicing rights acquired in the Flow Two Purchase and the Follow On Offering Purchases. Data regarding outstanding servicing advances for the quarters ended December 31, 2009 through March 31, 2012 is not shown, as Ocwen does not have complete historical information for periods prior to Ocwen’s ownership.

 

Quarter Ended

   Unpaid Principal
Balance
     Amount of Outstanding
Servicing Advances
     Advance Ratio  
     (dollars in millions)  

June 30, 2012

   $ 30,911         1,081         3.5

September 30, 2012

   $ 29,812         1,025         3.4

Servicing advances related to the Acquired Mortgage Servicing Rights were comprised of the following advance types at September 30, 2012 (dollars in millions):

 

Principal and Interest

   $ 564   

Escrow Advances

     642   

Corporate Advances

     240   
  

 

 

 

Total

   $ 1,446   
  

 

 

 

With respect the Planned Acquisition Assets, we expect the related servicing advances to have an advance ratio and composition similar to those currently exhibited by the servicing advances related to previous assets purchased from Ocwen.

The amount of each type of servicing advance outstanding can vary within each month and between months based on the timing of borrower payments, the receipt of loan payoff proceeds, the due dates of tax and insurance payments and other factors. Therefore, these amounts may not be indicative of the amount or the relative proportions of servicing advances that may be outstanding at any time in the future.

 

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Match Funded Liabilities

All of the outstanding advances associated with the Acquired Mortgage Servicing Rights are currently financed by the Servicing Advance Facility. Match funded liabilities are a form of non-recourse debt that are collateralized by, and are intended to approximate the duration of, the servicing advances. Our current match funded liabilities with respect to the Acquired Mortgage Servicing Rights are financed pursuant to the Servicing Advance Facility. We record the facility at its book value, which is the same as its fair value as of the date of acquisition. Our match funded liability balance is driven primarily by the level of servicing advances and the advance borrowing rate, which is defined as the collateral value of servicing advances divided by total servicing advances. For the Servicing Advance Facility, the advance borrowing rates, which are different for each type of advance: judicial and non-judicial; principal and interest; taxes and insurance; and corporate advances, were set at levels that enabled each class of notes issued pursuant to the advance financing facility to meet ratings criteria as determined by Standard & Poor’s.

The following table shows the match funded liabilities related to the Acquired Mortgage Servicing Rights as of September 30, 2012.

Match Funded Liabilities

As of September 30, 2012

 

(Dollars in millions)

Borrowing Type

  Interest Rate(1)   Maturity(2)     Amortization
Date(2)
    Unused
Borrowing
Capacity(3)
    Balance Outstanding  
          September 30,
2012
    December 31,
2011
 

Class A Term Note

  1-Month LIBOR + 225 bps     Aug. 2043        Aug. 2013      $      $ 496,494      $   

Class B Term Note

  1-Month LIBOR + 525 bps     Aug. 2043        Aug. 2013               52,176          

Class C Term Note

  1-Month LIBOR + 625 bps     Aug. 2043        Aug. 2013               26,457          

Class D Term Note

  1-Month LIBOR + 725 bps     Aug. 2043        Aug. 2013               24,873          

Class A Variable Funding Note

  1-Month LIBOR + 250 bps     Aug. 2043        Aug. 2013        23,074        295,882          

Class B Variable Funding Note

  1-Month LIBOR + 550 bps     Aug. 2043        Aug. 2013        9,702        30,969          

Class C Variable Funding Note

  1-Month LIBOR + 650 bps     Aug. 2043        Aug. 2013        5,107        15,730          

Class D Variable Funding Note

  1-Month LIBOR + 750 bps     Aug. 2043        Aug. 2013        4,705        14,831          

Class A Term Money Market Fund Note

  65 bps     Sep. 2013        Sep. 2012               244,615          

Class B Term Money Market Fund Note

  275 bps     Sep. 2044        Sep. 2014               28,500          

Class A Draw Money Market Fund Note

  1-Month LIBOR + 200 bps     Sep. 2044        Sep. 2014               20,385          
       

 

 

   

 

 

   

 

 

 

Total

        $ 42,588      $ 1,250,912      $   
       

 

 

   

 

 

   

 

 

 

 

(1) The weighted average interest rate at September 30, 2012 was 2.90%. We pay interest monthly.
(2) The amortization date is the date on which the revolving period ends under each Advance Facility note and repayment of the outstanding balance must begin if the note is not renewed or extended. The maturity date is the date on which all outstanding balances must be repaid. After the amortization date, all collections that represent the repayment of advances pledged to the facility must be applied to reduce the balance of the note outstanding, and any new advances are ineligible to be financed.
(3) Our unused borrowing capacity is available to us if we have additional eligible collateral to pledge and other conditions to borrowing are met. We pay a 0.75% fee on unused borrowing capacity. As of September 30, 2012, there were insufficient eligible servicing advances available to support any additional borrowings under this facility.

Interest rates on match funded liabilities vary based on the priority of such match funded liability to receive payments from the servicing advances securing the advance financing facility.

 

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On October 17, 2012, we completed the issuance of $250,000 of one-year and $450,000 of three-year term notes secured by servicing advance receivables at a weighted average interest spread over LIBOR of 1.55%. The proceeds were used to repay $600,000 in Class A through D term notes and to reduce borrowings on our Class A through D variable funding notes with a weighted average interest spread over LIBOR of 2.93%. Below is a schedule of the term notes by class:

 

Borrowing Type

   Amount      Maturity      Amortization
Date
     Interest
Rate
(Yield)
 

Class A-1 Term Note

   $ 215,067         October 2043         October 2013         135 bps   

Class B-1 Term Note

     17,807         October 2043         October 2013         175 bps   

Class C-1 Term Note

     8,903         October 2043         October 2013         325 bps   

Class D-1 Term Note

     8,223         October 2043         October 2013         400 bps   

Class A-2 Term Note

     387,121         October 2045         October 2015         200 bps   

Class B-2 Term Note

     32,053         October 2045         October 2015         250 bps   

Class C-2 Term Note

     16,026         October 2045         October 2015         400 bps   

Class D-2 Term Note

     14,800         October 2045         October 2015         500 bps   

The pro forma match funded liabilities data presented below is a hypothetical illustration provided for informational purposes only, is subject to a number of uncertainties and assumptions and does not intend to represent what our actual match funded liabilities would have been if we had owned the mortgage servicing rights and servicing advances purchased in the Initial Ocwen Purchase for the periods beginning December 31, 2009 through June 30, 2010. The amounts disclosed for September 30, 2010 through September 30, 2012 represent actual match funded liabilities under the match funded advance financing facility that we assumed from Ocwen in the Initial Ocwen Purchase. In preparing this information, we used currently available information and made assumptions that our management believes are reasonable in order to reflect match funded liabilities information for the periods presented. The estimates and assumptions used in the calculation of this information may be materially different from what we would have experienced and what we will actually experience in the future. Accordingly, the pro forma match funded liabilities information included below does not intend to represent what our match funded liabilities would have been had we operated as an independent public company during the periods presented. The pro forma match funded liabilities information also does not intend to represent what our match funded liabilities, results of operations or financial condition will be in the future, nor does it give effect to any events other than those discussed above.

 

Quarter Ended

   Match Funded Liabilities  
     (dollars in millions)  

December 31, 2009

   $ 916   

March 31, 2010

   $ 938   

June 30, 2010

   $ 890   

September 30, 2010

   $ 799   

December 31, 2010

   $ 786   

March 31, 2011

   $ 606   

June 30, 2011

   $ 493   

September 30, 2011

   $ 452   

December 31, 2011

   $ 371   

March 31, 2012

   $ 357   

June 30, 2012

   $ 368   

September 30, 2012

   $ 1,251   

Historical match funded liabilities may not be indicative of future amounts as servicing advance balances are subject to prepayment speeds, delinquency rates, foreclosure timelines, the time required to dispose of real estate owned properties and other factors that can affect the amount of servicing advances on mortgage loans. In addition, we may choose to manage our liquidity and interest expense by foregoing permitted borrowing on our match funded advance financing facility.

 

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Advance Borrowing Rate

The advance borrowing rate is the percentage of the amount of our outstanding servicing advances against which we can borrow. The rates shown in the table below apply to the servicing advances associated with the Acquired Mortgage Servicing Rights that are financed under the Servicing Advance Facility. These advance borrowing rates are key factors that influence the amount of our match funded liabilities and associated interest expense. A higher advance borrowing rate enables us to borrow more on our outstanding servicing advances and improves our return on equity and liquidity but also increases our interest expense. Advance borrowing rates vary based on the type of servicing advance and the occurrence of certain specified events. In addition, we are able to pledge deferred servicing fees as collateral for our match funded liabilities (not shown in the table below).

The table below shows the advance borrowing rate that applies to each type of servicing advance when calculating the maximum amount of each series of notes that may be outstanding pursuant to the Servicing Advance Facility. In addition, we are able to pledge deferred servicing fees as collateral for our match funded liabilities.

 

     As of September 30, 2012
Advance Borrowing Rate
 

Servicing Advance Type

   T1 Series     VF1 Series     MM1 Series  

Judicial States:

      

Principal and Interest

     91.50     91.50     84.25

Escrow Advances

     87.00     87.00     76.00

Corporate Advances

     88.00     88.00     79.25

Non-Judicial States:

      

Principal Advances

     94.00     94.00     90.00

Escrow Advances

     91.75     91.75     87.75

Corporate Advances

     92.25     92.25     87.70

Series Weighted Average Advance Borrowing Rate as of September 30, 20121

     89.93     89.93     82.55

 

(1) The Series Weighted Average Advance Borrowing Rate is the weighted average of the advance borrowing rates applicable to the servicing advances of each servicing advance type outstanding as of the specified date.

Description of the Aggregate Purchased Assets

The mortgage loan pools underlying the Acquired Mortgage Servicing Rights are characterized in terms of the loan category, geographic location of the mortgaged properties, delinquency status, year of origination, mortgage type, average borrower FICO score, average loan-to-value ratio and historical loan prepayment speeds. Each of these factors may impact one or more components of our financial condition or results of operations.

 

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The following tables present a number of important metrics that drive our financial performance and the results of our operations. All loan counts shown in the following tables are expressed in units.

Servicing Portfolio by Loan Category

Each loan category has different characteristics with respect to delinquency rates and prepayment rates. These differences drive Mortgage Servicing Asset valuations, servicing fees received, float revenue, subservicing expense, amortization expense and interest expense relating to the Acquired Mortgage Servicing Rights.

 

     As of September 30, 2012  

Category

   Number
of
Loans
     Average Unpaid
Principal Balance
per Loan
    Total Unpaid
Principal
Balance
     Fair Value
Mortgage Servicing
Rights Balance
 
            (dollars in
thousands)
    (dollars in millions)  

Subprime Loans

     300,623       $ 143      $ 43,019       $ 164   

Alt-A Loans

     17,110         205        3,505         14   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

     317,733       $ 147 1    $ 46,524       $ 178   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Represents the weighted-average unpaid principal balance of subprime and Alt-A mortgage loans.

We anticipate that the categories of mortgage loans underlying the Planned Acquisition Assets will be similar to those currently underlying the Acquired Mortgage Servicing Rights.

Mortgage Loans by State or Territory

The Acquired Mortgage Servicing Rights relate to mortgage loans on properties throughout the United States and its territories. Historical and current economic and market conditions are different in each region, and the geographic distribution of the mortgaged properties can have a direct impact on the overall performance of the mortgage loans underlying the Acquired Mortgage Servicing Rights.

 

     As of September 30, 2012  

(Dollars in millions)

State/Territory

   Number of
Loans
     Total Unpaid Principal
Balance
     Percent of Total
Loans
    Percent of Total Unpaid
Principal Balance
 

Alabama

     2,429         201         0.8     0.4

Alaska

     268         44         0.1     0.1

Arizona

     7,929         1,061         2.5     2.3

Arkansas

     1,708         129         0.5     0.3

California

     39,452         10,127         12.4     21.8

Colorado

     5,388         678         1.7     1.5

Connecticut

     4,638         794         1.5     1.7

Delaware

     1,177         165         0.4     0.4

Florida

     33,740         4,689         10.6     10.1

Georgia

     9,599         969         3.0     2.1

Hawaii

     1,952         560         0.6     1.2

Idaho

     1,024         105         0.3     0.2

Illinois

     15,801         2,161         5.0     4.6

Indiana

     6,120         486         1.9     1.0

Iowa

     1,237         94         0.4     0.2

Kansas

     1,408         114         0.4     0.2

Kentucky

     2,708         221         0.9     0.5

Louisiana

     4,123         361         1.3     0.8

Maine

     1,218         147         0.4     0.3

Maryland

     8,593         1,651         2.7     3.5

Massachusetts

     5,597         1,119         1.8     2.4

 

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Table of Contents
     As of September 30, 2012  

(Dollars in millions)

State/Territory

   Number
of
Loans
     Total
Unpaid
Principal
Balance
     Percent
of Total
Loans
    Percent
of Total
Unpaid
Principal
Balance
 

Michigan

     9,251         839         2.9     1.8

Minnesota

     4,271         548         1.3     1.2

Mississippi

     2,174         173         0.7     0.4

Missouri

     5,012         415         1.6     0.9

Montana

     318         37         0.1     0.1

Nebraska

     1,033         84         0.3     0.2

Nevada

     3,762         627         1.2     1.3

New Hampshire

     1,333         200         0.4     0.4

New Jersey

     8,603         1,843         2.7     4.0

New Mexico

     1,402         156         0.4     0.3

New York

     21,043         5,238         6.6     11.3

North Carolina

     7,304         670         2.3     1.4

North Dakota

     87         7         0.0     0.0

Ohio

     13,125         1,139         4.1     2.4

Oklahoma

     2,651         199         0.8     0.4

Oregon

     3,480         524         1.1     1.1

Pennsylvania

     13,720         1,407         4.3     3.0

Rhode Island

     1,294         222         0.4     0.5

South Carolina

     3,996         350         1.3     0.8

South Dakota

     152         12         0.0     0.0

Tennessee

     6,558         558         2.1     1.2

Texas

     31,825         2,596         10.0     5.6

Utah

     1,802         243         0.6     0.5

Vermont

     328         44         0.1     0.1

Virginia

     6,419         987         2.0     2.1

Washington

     5,885         981         1.9     2.1

Washington, D.C.

     478         102         0.2     0.2

West Virginia

     546         44         0.2     0.1

Wisconsin

     3,549         378         1.1     0.8

Wyoming

     223         25         0.1     0.1
  

 

 

    

 

 

    

 

 

   

 

 

 
     317,733       $ 46,524         100.0     100.0
  

 

 

    

 

 

    

 

 

   

 

 

 

We anticipate that the geographic distribution of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Acquired Mortgage Servicing Rights.

 

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Delinquency Status

The servicer is contractually obligated to advance funds to the securitization trust or other third parties during any period in which a borrower is delinquent. As a result, the delinquency status of a loan directly influences the level of servicing advances, match funded liabilities and interest expense with respect to the Acquired Mortgage Servicing Rights. In addition to external trends, such as unemployment rates and general economic conditions, delinquency status is highly dependent on the underwriting standards relating to loan origination and the processes, procedures and performance of the servicer or subservicer of a pool of mortgage loans.

 

     As of September 30, 2012  

Status

   Number of
Loans
     Total Unpaid
Principal Balance
     Percent of Total
Number of
Loans
    Percent of Total
Unpaid Principal
Balance
 
     (dollars in millions)  

Current

     227,050       $ 30,278         71.5     65.1

Delinquent(1)

          

30-59 days

     17,066         2,502         5.4     5.4

60-89 days

     4,882         738         1.5     1.6

90 days or more

     10,893         1,733         3.4     3.7

Borrower has filed for bankruptcy

     13,806         2,149         4.3     4.6

Forbearance

     7,118         1,482         2.2     3.2

Foreclosure

     31,372         6,580         9.9     14.1

Real Estate Owned (property has been foreclosed)

     5,546         1,062         1.8     2.3
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     317,733       $ 46,524         100.0     100.0
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Does not include foreclosures and bankruptcies.

We anticipate that the delinquency status of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Acquired Mortgage Servicing Rights.

Definitions used in this table are as follows:

 

   

“Current” means that the borrower has made all payments and the loan is current.

 

   

“30-59 days” means that the borrower has missed one monthly mortgage payment.

 

   

“60-89 days” means that the borrower has missed two monthly mortgage payments.

 

   

“90 days or more” means that the borrower has missed three or more monthly mortgage payments.

 

   

“Borrower has filed for bankruptcy” means that the servicer has been notified that the borrower has filed for bankruptcy and may be continuing to make payments or may be delinquent.

 

   

“Forbearance” means a temporary postponement of mortgage payments to give the borrower time to make up for overdue payments. Borrowers who are in the process of completing a loan modification are also classified in the forbearance category.

 

   

“Foreclosure” means that the servicer has started foreclosure proceedings. The time to complete a foreclosure proceeding varies by jurisdiction. Foreclosure proceedings usually begin when a borrower has missed three monthly mortgage payments.

 

   

“Real Estate Owned” means the foreclosure process has been completed and the securitization trust owns the property.

Loans that are less than 90 days delinquent and loans that are in bankruptcy or forbearance for which payments are being received are generally referred to as “performing loans,” while loans 90 days or more delinquent and loans in forbearance or bankruptcy for which payments are not being received or are in foreclosure or real estate owned are considered “non-performing loans.”

 

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An important part of Ocwen Loan Servicing’s activities is foreclosure prevention and home retention procedures, which are designed to help reduce delinquencies and assist borrowers in staying in their homes. Ocwen Loan Servicing may engage in early intervention activities with individual borrowers who are delinquent or whom risk models indicate may become delinquent.

The pooling and servicing agreements relating to the Acquired Mortgage Servicing Rights and those anticipated to be included in the Planned Acquisition Assets generally permit the servicer to engage in loan modifications. Loan modifications can include principal forgiveness, maturity extension, delinquent interest capitalization and changes to contractual interest rates. The servicer can agree to modifications upon liquidation of a loan, commonly known as a short sale, where a portion of the outstanding principal of the loan is forgiven as part of a sale of the underlying property to a third party. Ocwen Loan Servicing participates in a variety of governmental and agency-sponsored programs, as well as internally designed proprietary programs, aimed at borrowers who are at risk of foreclosure. Each program has varying qualification criteria for the borrower to meet as well as associated modification options, which will be analyzed to determine the best solution for the borrower. Each of these actions serves to reduce delinquencies, recover servicing advances and lower interest expense given that such actions yield more rapid servicing advance recoveries than the foreclosure and subsequent sale of mortgaged properties.

Year of Origination

The year of origination and resulting age of a mortgage loan are key drivers of prepayments. Prepayment speeds tend to be more volatile with newly originated mortgage loans compared to more seasoned loans, such as the loans underlying the Acquired Mortgage Servicing Rights. Prepayments result from the ordinary amortization of loans through monthly payments, proceeds of sales, short sales and refinancing, loan reductions through principal reduction modifications or resolution through foreclosure and sale.

 

     As of September 30, 2012  

Origination Year

   Number of
Loans
     Total Unpaid
Principal Balance
     Percent of Total
Number of Loans
    Percent of Total
Unpaid Principal
Balance
 
     (dollars in millions)  

Prior to 2005

     82,000       $ 8,858         25.8     19.0

2005

     91,102         12,892         28.7     27.7

2006

     107,278         17,304         33.8     37.2

2007

     37,235         7,441         11.7     16.0

2008

     115         29         0.0     0.1

2009

     3         0         0.0     0.0
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     317,733       $ 46,524         100     100
  

 

 

    

 

 

    

 

 

   

 

 

 

We anticipate that the seasoning of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Acquired Mortgage Servicing Rights.

 

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Mortgage Type

There are a variety of fixed and variable rate mortgage loans underlying the Acquired Mortgage Servicing Rights. The type of mortgage loan influences the prepayment speed and, to some extent, the delinquency rate of the loan. Mortgage type can change as loans are modified, and the mix can also change over time based on varying prepayment speeds across individual mortgage types.

 

     As of September 30, 2012  

Mortgage Type

   Number of
Loans
     Total Unpaid
Principal Balance
     Percent of Total
Number of Loans
    Percent of Total
Unpaid Principal
Balance
 
     (dollars in millions)  

1/29

     240       $ 22         0.1     0.0

2/28

     45,648         7,366         14.4     15.8

3/27

     12,514         2,045         3.9     4.4

5/25

     2,963         624         0.9     1.3

ARM6

     249         32         0.1     0.1

Other ARM

     4,006         1,191         1.3     2.6

Fixed Rate

     252,113         35,244         79.3     75.8
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     317,733       $ 46,524         100.0     100.0
  

 

 

    

 

 

    

 

 

   

 

 

 

We anticipate that the mix of the types of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Acquired Mortgage Servicing Rights.

A description of the terms used in the above table are as follows:

 

   

Variable rate loans include 1/29, 2/28, 3/27, 5/25, ARM6 and Other ARM. For example, a 3/27 adjustable rate mortgage has a three-year fixed interest rate period after which the interest rate begins to float based on an index plus a margin (known as the fully indexed interest rate). Other ARM represents loans with terms that do not fall into the definition of any other standard products.

 

   

Fixed rate loans have a stated fixed rate determined at loan origination for the full term of the loan.

Variable rate loans are generally based on the six-month LIBOR rate published in The Wall Street Journal. Fixed rate loans range from a minimum rate of 1.00% to a maximum rate of 16.875% with a weighted-average rate of 4.84%. Fixed rate loans include loans that were originated as variable rate loans but that have been subsequently modified and converted into fixed rate loans.

FICO Score

FICO score is a type of credit score prepared by Fair Isaac Corporation. A credit score is a numerical expression of a person’s creditworthiness based upon a statistical analysis of the information about them available to a credit bureau as of a particular date. A FICO score is usually obtained by a lender when it is underwriting a mortgage loan and is one of the factors that the lender will assess when deciding whether to extend a mortgage loan. High FICO scores generally indicate a higher degree of creditworthiness than low scores. A servicer may obtain updated FICO scores at various times over the life of the loan.

 

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The table below sets forth the weighted average FICO score, based on unpaid principal balance, for the borrowers with respect to the mortgage loans underlying the Acquired Mortgage Servicing Rights. The scores represent the average FICO scores that have been received between January 1, 2010 and September 30, 2012. The borrower’s most current score is most reflective of their current credit standing and would be used by a lender to assess any new borrowing or refinancing of an existing loan.

 

Mortgage Type

   Average FICO
Score Updated
as of September, 30, 2012
 

1/29

     659   

2/28

     623   

3/27

     634   

5/25

     665   

ARM6

     686   

Other ARM

     703   

Fixed Rate

     614   

We anticipate that the FICO scores of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Acquired Mortgage Servicing Rights.

Loan-to-Value Ratio

Loan-to-value ratio is the ratio of the outstanding balance of a mortgage loan to the estimated fair market value of the property securing the related mortgage loan as of the time of the most recent valuation of such property. A servicer will generally not obtain an updated estimated fair market property value for a mortgaged property unless the mortgage loan is delinquent. Thus, for loans that have never been seriously delinquent, the estimated fair market property value is generally the appraised value of the property at the time of origination. A servicer will obtain an updated estimated fair market property value for a property securing a mortgage loan when the loan becomes seriously delinquent and will generally receive a further updated estimate every 180 days thereafter. For properties that the servicer has foreclosed, the property value represents the current listing price for the property, where available, or the latest estimated fair market value of the property.

The table below sets forth the weighted average loan-to-value ratios, based on unpaid principal balance, for the mortgage loans underlying the Acquired Mortgage Servicing Rights. The loan-to-value ratios in the left-hand column of the following table represent the average loan-to-value ratios for those mortgage loans for which the most recent estimated property value was received prior to January 1, 2010 (and which may have been at the time of loan origination). We have received updated estimated property values since January 1, 2010 for the properties securing approximately 65.4% of the unpaid principal balance relating to the mortgage loans underlying the Acquired Mortgage Servicing Rights. Because a number of areas in the United States have been experiencing a decrease in the values of residential properties over the last several years, property value estimates that have not been recently updated may no longer accurately reflect the current value of a property. The loan-to-value ratios in the right-hand column represent the average loan-to-value ratios for those mortgage loans for which the most recent estimated property value was received between January 1, 2010 and September 30, 2012. Thus, we believe that the loan-to-value ratios shown in the right-hand column of the table are a better indication of the loan-to-value ratios for the mortgage loans underlying the Acquired Mortgage Servicing Rights using current estimates of property values and would be similar to the values a lender would use to assess any new borrowing or refinancing of an existing loan.

 

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Acquired Mortgage Servicing Rights by Loan-to-Value Ratio

 

     As of September 30, 2012  

Mortgage Type

   Average Loan-to-
Value Ratio
Market Value Not
Updated Since
January 1, 2010
    Average Loan-to-
Value Ratio Market
Value Updated
Between January 1,
2010
and September 30, 2012
 

1/29

     47     95

2/28

     77     124

3/27

     74     123

5/25

     65     120

ARM6

     60     76

Other ARM

     71     134

Fixed Rate

     55     99

We anticipate that the loan-to-value rations of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Acquired Mortgage Servicing Rights.

Aggregate Annualized Prepayment Speed

Prepayment speed refers to the annualized percentage by which the unpaid principal balance of a pool of mortgage loans declines due to ordinary amortization and monthly principal payments, early loan payoff due to refinancing or sale of the property, principal reduction loan modification or foreclosure and subsequent sale. Prepayment speed is a fundamental driver of the unpaid principal balance upon which servicing fees, subservicing expense, Mortgage Servicing Assets amortization expense, interest expense, servicing advances, match funded liabilities and the valuation of Mortgage Servicing Assets are based. Prepayment speed is driven by many external factors, including prevailing market mortgage interest rates, unemployment rates, real estate valuation trends and the ability of borrowers to qualify for new loans. In general, prepayment speeds for subprime and Alt-A mortgage loans tend to be more stable than for prime mortgage loans because subprime and Alt-A borrowers are less sensitive to interest rate fluctuations given that they have fewer refinancing opportunities and are less likely to qualify for new loans. The quality of the servicer or subservicer is also a significant determinant of prepayment speed as successful loss mitigation techniques tend to reduce prepayment speeds. The table below sets forth the prepayment speeds related to the mortgage servicing rights acquired in the Initial Ocwen Purchase and the Flow One Purchase.

 

Quarter Ended

   Aggregate Annualized Prepayment Speed  

December 31, 2009

     22.0

March 31, 2010

     18.0

June 30, 2010

     17.6

September 30, 2010

     18.5

December 31, 2010

     13.5

March 31, 2011

     15.4

June 30, 2011

     14.8

September 30, 2011

     16.1

December 31, 2011

     15.1

March 31, 2012

     14.5

June 30, 2012

     15.3

September 30, 2012

     12.8

The table below sets forth the prepayment speeds related to mortgage servicing rights acquired in the Flow Two Purchase and the Follow On Offering Purchases. December 31, 2009 through June 30, 2012 data is excluded, as Ocwen does not have complete historical information.

 

Quarter Ended

   Aggregate Annualized Prepayment Speed  

September 30, 2012

     13.5

 

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In general, prepayment speeds tend to decline as a pool of mortgage loans ages. The current industry prepayment speed assumption used by management to value the Acquired Mortgage Servicing Rights is approximately 18% per annum. We anticipate that the prepayment speeds for the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Acquired Mortgage Servicing Rights.

Liquidity and Capital Resources

We define liquidity as unencumbered cash balances plus unused, collateralized advance financing capacity. Our liquidity as of September 30, 2012, as measured by cash and available credit, was $33,750, an increase of $33,467 from December 31, 2011. At September 30, 2012, our cash position was $33,750 compared to $283 at December 31, 2011, and we were fully borrowed on our advance financing facility based on the collateral pledged at September 30, 2012. Our investment policies emphasize principal preservation and availability and limit the investments to demand deposit accounts.

Over time, we expect to acquire substantially all of Ocwen Loan Servicing’s remaining mortgage servicing rights relating to subprime and Alt-A mortgage loans. As of September 30, 2012, these remaining mortgage servicing rights had approximately $63.8 billion of unpaid principal balance, a fair market value of $187 million and match funded servicing advances of approximately $2.6 billion.

Our ability to acquire Ocwen Loan Servicing’s remaining mortgage servicing rights will largely depend on our ability to enter into or increase the size of match funded financing facilities and to raise additional capital through the sale of additional ordinary shares. While we do not currently have commitments for new match funded advance financing, we believe we are well positioned to obtain future financing facilities. Our ability to raise future equity capital is dependent on our ability to access the capital markets on attractive terms. In addition, the provisions of our Articles of Association restrict our ability to issue and sell additional ordinary shares at a price below our then current net asset value per share without first obtaining the prior approval of holders of at least a majority of the outstanding ordinary shares voted with respect to such approval. Any issuance of additional ordinary shares would be dilutive to our existing shareholders, including shareholders that purchase in this offering.

Investment Policy, Funding Strategy and Interest Income

Our primary sources of funds for near-term liquidity are:

 

   

Interest income—Notes Receivable – Rights to MSRs and

 

   

proceeds from match funded liabilities.

An expected long-term source of liquidity is the proceeds from the issuance of equity capital.

Our primary uses of funds are:

 

   

payments for advances in excess of collections on our existing servicing portfolio;

 

   

payments of interest and operating costs;

 

   

purchases of MSRs and related servicing advances and

 

   

repayments of borrowings.

In managing our liquidity position, our primary focus is on maintaining sufficient cash and unused borrowing capacity to meet our advancing obligations, pay expenses and purchase additional assets. We regularly monitor and project our cash position and borrowing capacity and consider this in sizing asset purchases.

 

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At September 30, 2012, $42,588 of our total maximum borrowing capacity remained unused. We maintain unused borrowing capacity for two reasons:

 

   

as a protection should advances increase due to increased delinquencies and

 

   

to provide capacity for the acquisition of additional servicing rights.

Our advance financing facilities require that we maintain minimum levels of liquid assets and earnings. Failure to comply with these covenants would result in restrictions on new borrowings or the early termination of our advance financing facilities.

Outlook

We believe that our cash balance and unused advance financing capacity are sufficient to meet foreseeable requirements.

Debt Financing Summary

On March 5, 2012, we assumed an existing advance financing facility from Ocwen in connection with the Initial Ocwen Purchase. On September 13, 2012, we amended and restated the servicing advance facility agreements that we originally entered into simultaneously with the closing of our initial public offering and the Initial Ocwen Purchase to (i) add Wells Fargo Securities, LLC as an administrative agent, (ii) create a master trust (the “Trust”) that can issue multiple series of notes with varying maturity dates and credit ratings ranging from AAA to BBB, including 2a-7 money market eligible notes and medium term notes and (iii) allow for deferred servicing fees to be included in the borrowing base as principal and interest advances for pooling and servicing agreements that meet certain conditions. This resulted in a reduced cost of our financing. On September 13, 2012, pursuant to the series 2012-MM1 indenture supplement, the Trust issued a $265 million Rule 2a-7 money market eligible note with a one-year term and a fixed interest rate per annum of 0.65%. The Trust also issued a “Class A” draw note with an expected two-year term and a variable interest rate of one month LIBOR + 200 bps. On September 28, 2012, in connection with the closing of the second of the Follow On Offering Purchases, the Trust issued a $28.5 million Class B note with a two-year term and a fixed interest rate per annum of 2.75%.

Our ability to continue to pledge collateral under our advance facility depends on the performance of the collateral. Currently, the large majority of our collateral qualifies for financing. The debt covenants for our Advance Facility require that we maintain minimum levels of liquid assets and unused capacity. Failure to comply with these covenants could result in restrictions on new borrowings or the early termination of our Advance Facility. We believe we are in compliance with these covenants and